Orion Advisor Solutions

What Ails the US Dollar?

The US dollar surged to a 20-year high in 2022 due to rapid Federal Reserve rate hikes and global risk aversion, which helped curb domestic inflation but raised international costs and debt burdens, while its subsequent decline in 2023—driven by a nearing end to Fed hikes, hawkish foreign central banks, and improved global economic conditions—has boosted non-US equities and is anticipated to enhance US multinational earnings.

The US dollar experienced a significant rally in 2022, with the ICE U.S. Dollar Index rising from 96 in January to 114 on September 28th, marking a 20-year high. This index measures the value of the dollar against a basket of foreign currencies. The primary drivers behind this surge were the Federal Reserve's rapid interest rate increases—the fastest in 40 years—which made the dollar more attractive to investors, and a global flight to safety, as the dollar has historically benefited during periods of global distress.

The strong dollar had mixed effects on the global economy and markets. Domestically, it helped suppress inflation. Internationally, however, it contributed to higher inflation, as most commodities are priced in dollars, making goods more expensive outside the US. It also negatively impacted US multinational companies by reducing the value of their overseas earnings when converted back to dollars. Additionally, it increased borrowing costs for companies and countries with dollar-denominated debt, as more dollars were needed to service these obligations. Conversely, US consumers benefited, as a strong dollar increased their purchasing power for imported goods.

Since reaching its peak in late 2022, the ICE U.S. Dollar Index has declined to 102. This drop has prompted questions about the causes of the dollar's weakness and its implications for the global economy and markets in 2023. Several factors have contributed to the dollar's decline:

  • The Federal Reserve is now closer to ending its rate hiking cycle.
  • Central banks outside the US have become more hawkish.
  • Key global economies have seen improved fundamentals, such as lower energy prices in Western Europe and China easing its Covid-19 lockdown policies.

The weaker dollar has supported a notable rally in non-US equities, with developed market equities up 23% and emerging market equities up 18% over the previous three months. It is also expected to benefit US multinational earnings in 2023, as overseas earnings will be worth more when converted into dollars. Overall, a weaker dollar is generally seen as positive for the global economy and risk assets in 2023.