The Buck Stops Here

Key Points

  • US dollar cycles are long. The most recent appears unusually so relative to history, suggesting the recent change in direction may be more than temporary.

  • In 2022, the Fed’s rate hikes were more aggressive than other developed-market central banks. In the face of continued high inflation, foreign central banks will likely pick up the pace in their rate hikes. The result should be a tightening of the interest rate differential, putting pressure on the US dollar, likely continuing the pullback that started in December 2022.

  • The dollar’s direction is an important consideration in portfolio positioning because of the asymmetric relationship between global asset returns and the price of the US dollar.

  • In a weakening dollar scenario, unhedged foreign stocks and bonds not only typically outperform, but are the only statistically reliable relative relationship we observe.

Over the last two years, the world has witnessed a parabolic strengthening of the US dollar compared to its developed-market counterparts. Dollar strengthening actually started just after the global financial crisis as a slow methodical slog higher marked by both pullbacks and rapid ascents. But it was only last summer that the stronger dollar began to make headlines as USD/JPY hit 135 (135 Yen = $1) and USD/EUR broke parity. As we start 2023, the dollar has pulled back 12% from its high in September 2022, but remains 25% elevated from its lows at the start of the last decade. Is this a temporary respite that reverses in a risk-off recession, or does the buck stop here?