How a Declining Dollar Impacts Investments

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The dollar may decline due to factors such as monetary policy, economic conditions, trade imbalances, geopolitical events, interest rate differentials, and market sentiment. A declining dollar increases import prices, leading to inflation and higher interest rates. This can slow down economic growth and negatively affect stock market valuations. On the positive side, it benefits export-oriented companies, boosts commodity prices, and makes foreign investments more attractive.

Over the past decade, the U.S. dollar has experienced significant volatility, influenced by economic policies such as the Federal Reserve's interest rate adjustments and global events such as trade wars and COVID-19. For instance, the U.S. Dollar Index (DXY) surged to nearly 103 in early 2020 due to safe haven demand during the pandemic but fell close to 89 by early 2021 following efforts for global economic recovery. Such movements lead to a noticeable impact on investors’ portfolios.

This article discusses how investors can hedge against a declining dollar by diversifying portfolios, investing in commodities, and using currency hedging strategies such as futures and options trading.

Investment impact of a declining dollar

Inflation and interest rates

When the dollar weakens, the Federal Reserve often raises interest rates to address inflation. Higher interest rates can slump economic activity and negatively affect stock market valuations. For example, during the late 1970s, the dollar's decline led to a double-digit inflation, driving the Federal Reserve to increase interest rates to over 20% in 1981. More recently, in 2021, as the dollar fell by about 10% from its peak in March 2020, inflation rates rose from 1.4% in January 2021 to 5.4% by June 2021, leading to discussions about potential rate hikes. Increased costs for goods and services during such periods reduce consumer purchasing power, impacting overall economic growth.

Impact on imports and exports

A cheaper dollar makes U.S. products more affordable abroad which in turn boosts exports. For instance, when the dollar weakened by about 5% against major currencies in 2019, U.S. exports of goods and services rose by 1.7%. This increase in export activity can significantly benefit industries such as manufacturing and agriculture.

However, a weaker dollar also makes imports more expensive. According to the U.S. Bureau of Labor Statistics, import prices rose by 10.6% in 2021 due to the dollar's decline, contributing to overall inflation. This increase in import costs can lead to higher prices for consumer goods, ranging from electronics to everyday household items, putting additional financial strain on consumers. Thus, while a weaker dollar can enhance U.S. competitiveness globally, it also results in higher domestic prices for imported goods.

Investment strategies in a declining dollar environment

Diversification

One of the best strategies to hedge against a declining dollar is diversification. Spreading investments across various asset classes and regions helps mitigate risks. For example, allocating portions of your portfolio to foreign stocks and bonds can benefit from potential currency appreciation. Historical data indicates that a diversified portfolio with international exposure can reduce volatility. As reported by a Vanguard study, portfolios with 20-30% international assets tend to have better risk-adjusted returns.

Example of diversified investment portfolio
Investments	Рortfolio share	Asset example
US Large Cap Stocks	15,0%	SPDR S&P 500 ETF (SPY)
US Government Bonds	15,0%	iShares 7-10 Year Treasury Bond ETF (IEF)
US Small/Mid Cap Stocks	10,0%	iShares Russell 2000 ETF (IWM)
International Stocks	10,0%	Vanguard FTSE All-World ex-US ETF (VEU)
Corporate Bonds	10,0%	iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)
Technology Stocks	5,0%	Invesco QQQ Trust (QQQ)
Energy Stocks	5,0%	Energy Select Sector SPDR Fund (XLE)
International Bonds	5,0%	Vanguard Total International Bond ETF (BNDX)
Gold	5,0%	SPDR Gold Shares (GLD)
Silver	5,0%	iShares Silver Trust (SLV)
Real Estate (REITs)	5,0%	Vanguard Real Estate ETF (VNQ)
Bank Deposits	5,0%	short-term deposit - 2%, long-term deposit - 3%
Private Real Estate Funds	2,5%	Fundrise, RealtyMogul, CrowdStreet
Cryptocurrencies	2,0%	Bitcoin, Ethereum, USDT
Active Altcoins	0,5%	Binance Coin (BNB), Cardano (ADA), Solana (SOL)

Focus on export-oriented companies

Companies with significant foreign revenue, like Apple and Microsoft, are more likely to benefit from a weaker dollar. In 2021, Apple generated 58% of its total revenue from international markets, while Microsoft earned 49% of its overall revenue overseas. When the dollar weakens, the value of these foreign revenues increases when converted back to dollars, enhancing their bottom line. This makes such companies attractive investments during periods of dollar decline.

Hedging strategies

Investors can use currency futures and options to hedge against dollar fluctuations. For example, buying futures contracts to lock in current exchange rates might be a better option to protect investments from an expected dollar depreciation. According to the CME Group, the average daily volume of U.S. dollar futures increased by 24% in 2023, highlighting their growing use as a hedging strategy.

Commodities and precious metals

Commodities like oil and gold frequently rise in value as the dollar weakens. As a result investing in commodity ETFs or physical gold can provide a hedge against the dollar's decline. Historical data shows a strong inverse relationship between gold prices and the dollar's value. In 2023, gold prices surged by 25% as the dollar weakened by 10%. Similarly, oil prices often increase as the dollar declines, providing another avenue for investment during such periods.

Sector-specific impacts

Technology and multinational corporations

Tech giants such as Apple and Microsoft benefit greatly from foreign sales when the dollar weakens. Their global reach means that a significant portion of their revenue comes from stronger foreign currencies, boosting their overall earnings. In 2023, Apple reported that 58% of its revenue came from international markets, while Microsoft generated 49% of its revenue from outside the U.S. When the dollar declines, these foreign earnings are worth more in dollar terms, enhancing the companies' profitability.

Energy and industrial commodities

A weak dollar often leads to higher commodity prices, benefiting sectors like energy and mining. Companies in these industries see increased profitability as their products, priced in dollars, fetch higher prices on the global market. For example, during periods of dollar weakness, oil prices typically rise. In 2023, the weakening dollar led to a more than 20% increase in crude oil prices, significantly boosting the revenues of energy companies.

Investment vehicles for a declining dollar

Stocks and exchange-traded funds (ETFs)

Several funds are well-positioned to gain from a weak dollar. For example, Vanguard International Growth and Baron Emerging Markets funds have shown strong performance in such environments, offering robust returns.

Several funds that are well-positioned to gain from a weak dollar
ETF	Expense Ratio	AUM	Top Holdings
iShares MSCI Emerging Markets ETF (EEM)	0.68%	$30.34 billion	Alibaba, Tencent, Samsung
Invesco DB Commodity Index Tracking Fund (DBC)	0.85%	$3.02 billion	Futures contracts on crude oil, gold, corn
Vanguard FTSE All-World ex-US ETF (VEU)	0.08%	$32.55 billion	Nestle, Roche Holding, Samsung

These ETFs are well-positioned to gain from a weaker dollar due to their international exposure and focus on commodities, which tend to appreciate when the dollar declines.

Bonds and fixed income

The bond market can be volatile in a declining dollar scenario. Investors are often encouraged to focus on bonds that offer protection against inflation or are denominated in stronger foreign currencies. Additionally, investing in foreign bonds denominated in currencies like euro or yen can provide a hedge against a weakening dollar. During periods of dollar decline, these foreign bonds can appreciate in value when converted back to U.S. dollars.

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Best Forex brokers
	Plus500	Pepperstone	OANDA	FOREX.com	Interactive Brokers
Min. deposit, $	100			100
Max. leverage	1:300	1:500	1:200	1:50	1:30
Min Spread EUR/USD, pips	0,5	0,5	0,1	0,7	0,2
Max Spread EUR/USD, pips	0,9	1,5	0,5	1,2	0,8
ETFs
Bonds
Stocks
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Risks and considerations

Keeping an eye on Federal Reserve policies and other economic indicators is highly important. Changes in interest rates, inflation reports, and employment data can provide clues about future dollar movements, helping investors adjust their strategies accordingly. For example, when the Federal Reserve hinted at raising interest rates in 2022, it signaled potential dollar strengthening, thus influencing investment decisions across various asset classes. Monitoring indicators such as the Consumer Price Index (CPI), Gross Domestic Product (GDP) growth rates, and the Federal Open Market Committee (FOMC) meeting minutes can help investors anticipate shifts in the dollar's value.

Each investor has a different risk tolerance. It is essential to tailor an investment strategy to your comfort level with potential losses. For example, an investor with a low risk tolerance might focus on safer assets like TIPS or high-quality foreign bonds, while a more risk-tolerant investor might look into commodities or stocks in emerging markets. Consulting a financial advisor can help create a plan that aligns with your financial goals and risk appetite. Advisors can provide personalized advice based on investors financial situation, helping to balance risk and return effectively.

What Are Economic Indicators And How Do They Affect The Forex Market?

Seeing a decline in the U.S. dollar index is a clear signal to rethink my investment strategies. For instance, a 10% decline in the dollar index can lead to a significant 3-5% increase in import prices, resulting in inflation. This often prompts the Federal Reserve to raise interest rates, which can trickle economic growth and shake stock market valuations.

As a hedging strategy, I invest in export-oriented companies like Apple and Microsoft, which generate over 60% of their revenue from international markets. Their foreign revenues increase when converted back to a weaker dollar. Diversifying my portfolio with foreign assets, which can appreciate as other currencies strengthen, is another strategy I use. Additionally, I consider investments in gold and commodities. Historically, gold prices have exhibited a strong inverse relationship with the dollar.

Conclusion

In summary, a declining dollar impacts investments in various ways, from boosting export-oriented companies to increasing commodity prices. Diversification, strategic hedging, and focusing on resilient sectors can help navigate this complex environment.

Staying up-to-date and having a versatile approach is key to managing investments in a declining dollar environment. By understanding the broader economic context and employing smart strategies, investors can turn potential challenges into opportunities.

FAQs

How does a declining dollar impact emerging markets?

A declining dollar benefits emerging markets by reducing their debt servicing costs and boosting commodity prices, which increases revenues for major exporters. Countries like Brazil and South Africa gain from higher prices for their raw materials and agricultural products.

What role do exchange-traded funds (ETFs) play in hedging against a declining dollar?

ETFs can hedge against a declining dollar by offering exposure to foreign currencies or commodities. Examples include the Invesco DB US Dollar Index Bearish Fund (UDN), which tracks the inverse performance of the dollar, and ETFs focused on foreign markets, providing diversification and protection.

How can a declining dollar affect the bond market, particularly for U.S. Treasuries?

A declining dollar can increase yields on U.S. Treasuries as foreign investors seek higher returns to offset currency losses. Rising inflation due to a weaker dollar can bring down real returns on fixed-income investments and affect bond market dynamics.

What are some advanced strategies investors can use to protect their portfolios from a declining dollar?

Advanced strategies include currency hedging with derivatives, global diversification, investing in hard assets like gold and real estate, and dynamic asset allocation. These can help mitigate risks and capitalize on opportunities when the dollar weakens.

Team that worked on the article

Parshwa is a content expert and finance professional possessing deep knowledge of stock and options trading, technical and fundamental analysis, and equity research. As a Chartered Accountant Finalist, Parshwa also has expertise in Forex, crypto trading, and personal taxation. His experience is showcased by a prolific body of over 100 articles on Forex, crypto, equity, and personal finance, alongside personalized advisory roles in tax consultation.

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Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.

Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO).

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