US dollar rallies have tended to last years, not months
Since the 1970s when the Bretton Woods fixed-currency regime ended and currencies began floating, a typical dollar rally has lasted roughly six to seven years. The increase in the dollar we’ve seen so far this year is muted compared with the strong dollar episodes of the early 1980s and late 1990s. The dollar’s recent rally may just be getting started. In addition, according to the BlackRock Investment Institute, dollar rallies tend to be self-reinforcing—a stronger dollar begets greater inflows into US assets in expectation of further dollar appreciation. For instance, US companies start hedging overseas earnings, increasing demand for dollars.
Market Realist – For how long can the current dollar rally last?
In the 1970s, the Bretton Woods fixed currency regime ended and currencies began floating. Since then, the US dollar (UUP) has tended to rally for years together. For example, as the graph above shows, between 1980 and 1985, the dollar index surged by 59.2%. The second such rally came between 1995 and 2002 when the dollar index rallied by 42.3%.
The current rally started in 2011. The dollar index has risen by 34.6% since. There could still be a couple of years left in the current dollar rally. However, there’s a long-term trend developing. Technically speaking, the dollar index has been making lower highs and lower lows. In other words, the dollar has been trending lower since the mid-1980s.
Implications for stocks
In the short-term, though, a stronger dollar represents a headwind. The higher dollar could stall the US economic recovery, as US exports become less competitive. Earnings expectations for the S&P 500 (SPY)(IVV) have declined steadily over the year.
Meanwhile, a weaker currency is a tailwind for both European (EZU) and Japanese stocks (EWJ). Cheaper valuation relative to US stocks also makes international developed markets stocks (EFA) more attractive.