Checking Under the Hood on King Dollar

Additional content provided by Brian Booe, Associate Analyst, Research.

As highlighted in previous LPL Research blogs this week (“Invest in the Long Term” and “Equity Markets Grapple With Tariffs”), market volatility and pullbacks are not uncommon by any means. Unfortunately, what is also not uncommon during bouts of volatility is headlines reliving previous crises that attempt to compare and draw parallels. One of those narratives as of late surrounds the dollar, facing its worst start to a year since 2008. But while the dollar may be experiencing some headwinds, this does not spell doom and gloom for King Dollar or the U.S.

Tariff and trade developments have dominated headlines, and it may be somewhat counterintuitive for the dollar to weaken, but it’s important to remember that movements in the greenback (and all currencies for that matter) are not limited to domestic events.

International Factors Placing Downward Pressure on the Dollar

Relative strength in fellow major world currencies has been a major headwind for the dollar in recent weeks. The euro has surged since markets turned the calendar to March on the back of Germany’s “whatever it takes” plan to amend their constitution and remove spending caps for defense and infrastructure. Further, the euro received support on ceasefire hopes for the war in Ukraine during peace talks between U.S. and Russian authorities. Most recently, Ukraine agreed to a temporary truce brokered by the U.S., now awaiting Russian approval. From another lens, Europe’s shared currency has also been boosted by foreign investors rotating to the Eurozone’s equity markets, chasing their strong start to the year.

On the other side of the globe, the Japanese yen has gained ground against the dollar since Inauguration Day. Yen strength since January arrived on rate hike hopes, with the Bank of Japan (BOJ) meeting minutes hinting at more rate hikes on the horizon as officials backed gradual increases, following a 0.25% increase delivered by the central bank in late January.

The Euro and Yen Have Strengthened Since January

Source: LPL Research, Bloomberg 03/12/25
Disclosures: Indexes are unmanaged and cannot be invested in directly.
Past performance is no guarantee of future results.

Headwinds on the Home Front Are a Factor, but May Be Overdone

Recent negative surprises in economic data have bolstered Federal Reserve (Fed) rate cut bets, which, broadly speaking, can place some downward pressure on the dollar as interest rate differentials narrow. The string of weaker-than-expected data also sparked growth concerns, which have weighed on market sentiment in the latest pullback, but the outlook for the dollar and the economy are not fatal, in our view. In short, it’s a growth scare, not a recession scare. U.S. gross domestic product (GDP) forecasts continue to outpace international economies, while income growth and the U.S. labor market remain steady and don’t signal recession. Reduced consumer demand recently highlighted by corporate America could be due in part to the negative wealth effect, resulting from the pause in big tech-led stock market gains, which have slowed returns for major averages in December and January. On the trade front, if tariffs are implemented, they could actually be dollar supportive as the traditional response is for countries to devalue their currency to offset the impact of the levies.

Conclusion

While international currency strength and headline risk have weighed on the dollar, this is not indicative of a pronounced economic downturn or the greenback losing its status as the world’s reserve currency (the White House has also stated its intent on maintaining this status). Technically, the dollar has returned to the middle of a two-year range, suggesting recent moves are not indicative of a definitive turn for the dollar. Trade and policy headlines will likely continue to create volatility, and while the U.S. economy may cool this year, economic growth will remain positive.

The LPL Research Strategic and Tactical Asset Allocation Committee (STAAC) holds a neutral view of the U.S. dollar, as the greenback may continue to face headwinds in the near term, but long-term movements will likely be rangebound. The Committee continues to prefer U.S. equities over developed international and emerging markets (EM) based on superior earnings and economic growth.