In addition, while weakness in the dollar may exacerbate the inflationary impact on US consumers with regard to tariffs, it will also likely aid the corporate earnings of large publicly traded US exporters, the types of companies that dominate the S&P 500. Thus, on balance, we remain bullish on US stocks in the absence of a recession, which we don’t expect. In addition, foreign currency strength recently made us more constructive on international markets, leading to our upgraded view of stocks in Europe and Japan.
The Cause of Dollar Weakness Matters for the Stock Market
Analysis of why the dollar is dropping relative to foreign currencies contains important implications for investors. If the dollar is declining primarily due to eroding global confidence in the US economy and its’ institutions, this is an undesirable outcome that is likely negative for US stocks. However, if instead the dollar is declining largely due to the expectation of future easing from the Federal Reserve, along with weak-dollar political policy and the USD’s overvaluation to start the year on a purchasing power parity (PPP) basis, then this likely is a more benign scenario for stocks. Our current view is that it has been a bit of both this year… but concerns around the destabilizing nature of tariffs have been overblown and are now starting to recede.
It is no coincidence that the dollar’s weakness this year has occurred against the backdrop of President Trump’s dramatic attempt to minimize trade deficits via the widespread use of tariffs. Investor concerns around the potential negative growth and inflation ramifications of such a policy had stocks, Treasuries and the US dollar all dropping simultaneously in April – a rare event. However, since April a fair amount of the aggressive rhetoric around tariffs has been walked back, and the US has been making progress at the negotiation table with China and others. Stocks and Treasuries have largely recovered, with the dollar stabilizing somewhat.
On the policy side, we believe President Trump, Treasury Secretary Scott Bessent, and others are campaigning for a weak dollar…and thus far are getting their wish. For an Administration hyper focused on rebuilding US manufacturing capability and narrowing trade imbalances with other countries, this makes sense; a cheaper dollar makes US exports more attractive to foreign consumers. The dollar’s valuation has heretofore likely been a drag on exports; looking at real effective exchange rates² or ‘REER,’ the dollar’s large rise over the past 15 or so years has likely hurt US export competitiveness (see Chart 2, below).
While a globally coordinated, multilateral agreement among US trade partners to weaken the dollar (ala 1985’s ‘Plaza Accord’) is unlikely today given contentious geopolitics and trade dynamics, we believe the US is capable of unilaterally pressuring the dollar… through policies both intentional and otherwise. Trump’s harsh rhetoric towards Fed Chair Jerome Powell gives investors unwelcome flashbacks to the pressure that then-President Richard Nixon applied to Fed Chair Arthur Burns in the 1970s. A loss of political independence at the Fed or a meaningful ‘revenge tax’ on foreign holdings of US assets, if either were to occur, could cause foreign holders of US-denominated assets to decrease holdings…though we believe the Treasury market is still ‘too big to fail’, as we wrote about two weeks ago. In addition, the current House-approved version of the Administration’s ‘One Big, Beautiful Bill’ is likely a deficit-buster in the unlikely event it is enacted in full by the Senate (the non-partisan Congressional Budget Office estimates the House proposal would add over $3T to the deficit over the next decade, according to Bloomberg). However, we believe neither situation will end up in ‘worst-case scenario’ territory; we believe that the Fed will remain independent, and that the ultimate bill that will be passed will be moderated by deficit hawks in the Senate.
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