Jul 16, 2021

Trying to Predict U.S. Dollar Returns in International Markets after U.S. Dollar strengthened

With the Federal Reserve starting to talk about raising interest rates, a concern has been that higher U.S. interest rates might be associated with a short run strengthening of the US dollar. What might higher interest rates and a stronger dollar mean for U.S. dollar returns from equity investments outside the US.? To begin, dollar rates of return could fall in all markets. Moreover, there might be additional effects in emerging markets where they might find it difficult to pay off dollar-denominated debt and are unable to refinance as money flows out due to rising yields in the U.S. Emerging market economies can be faced with a vicious cycle of poor US dollar returns in markets in which the currency is depreciating.

This paper looks at the historical record of when the US dollar strengthens over several months, which might happen if the U.S. Fed raises rates, what happens to U.S. dollar returns in the non-U.S. markets over the next month, 3 months, 6 months, and 12 months. For example, is it true that where the US dollar has been strong over the past 3 months relative to the local currency, do those equity markets do poorly in subsequent months in U.S. dollar returns relative to the U.S. equity market?

In this analysis, for each non-US developed market and each emerging market, after the US dollar strengthened over the previous three months relative to the foreign market’s currency, the U.S. dollar return for that market was subtracted from the U.S. market return. This is what will be called the “alpha” for each market. These alphas were computed after 1 month, 3 months, 6 months, and 12 months after the U.S. dollar strengthened. For all the markets, the returns were based on their respective MSCI dollar return indices. The alphas for the 1 month, 3 months, 6 months, and 12 months after U.S. dollar strengthening was averaged over 10-year periods for each set of markets as well as over several individual crisis years. In order to take out the bias which might arise during periods in which the U.S. market outperformed other developed and emerging markets, whether the U.S. dollar was strengthening or weakening, we did the same calculations for each non-US developed and emerging market 1, 3, 6, and 12 months after the US dollar weakened. We subtracted the two alphas – the average alpha when the U.S. dollar was strengthening minus the average alpha when the U.S. dollar was weakening. Figures 1, 2, 3, and 4 show the difference in alphas during the period of U.S. dollar strength minus periods of U.S. dollar weakness. Note, a positive number indicates the average return was higher in the non-U.S. markets than the U.S. market when the dollar was strengthening vs when the U.S. dollar was weakening and a negative number indicates the opposite – the average return was lower in the non-US market when the dollar was strengthening vs when it was weakening.

Figure 1

1-Month Alpha in Non-US Mkts over US Market During Times of U.S. $ Strength Minus U.S.$ Weakness

Dollar Blog 1

Figure 2

3-Month Alpha in Non-US Mkts over US Market During Times of U.S. $ Strength Minus U.S. $ Weakness

Dollar Blog 2

Figure 3

6-Month Alpha in Non-US Mkts over US Market During Times of U.S. $ Strength Minus U.S. $ Weakness

Dollar Blog 3

Figure 4

12-Month Alpha in Non-US Mkts over US Market Subtracting Times of U.S. $ Strength Minus U.S. $ Weakness

Dollar Blog 4


  • In the short run, non-US markets tended to perform worse relative to the U.S. market in the subsequent month after periods of U.S.$ strength than during periods of U.S.$ weakness
  • However, this is not always the case, as shown for non-U.S. developed and emerging markets during 1985 -1994 period.
  • Over longer periods, non-U.S. markets tended to perform better when the U.S.$ strengthened rather than when it weakened. An exception would be in years in which there were major currency crises in markets, such as during 1995-2004 which included the Asian Financial/Currency crises of 1997 and the Russian Financial/Currency crisis in 1998.

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