The U.S. dollar and euro reached parity the weekend after Friday, July 15 for the first time in two decades—a big deal for the world’s economies. This has global implications, but it’s important to understand why it’s happening.
Here’s why the dollar is so strong (and gaining strength as we speak), plus what it means for stock markets and economies the world over.
U.S. dollar gains strength against the euro
As of July 21, one U.S. dollar is equivalent to 0.98 euro. After reaching near-parity with one another for the first time in 20 years, the dollar continued to gain strength this week. The European Central Bank is poised to decide on interest rate hikes soon and the euro is having difficulty maintaining its value against the dollar.
It’s not just the dollar’s strength that has brought parity, but also the euro’s weakness. Like America, European Union (EU) nations are also experiencing painful inflation and are looking down the barrel of a potential recession.
To add to it, an energy price crisis is underway. Europe’s closeness to the Ukraine crisis and the vast sanctions the region has instituted against Russian oil (typically the area’s key oil supplier) are driving up prices. This is causing weakness in the euro.
Why the dollar is so strong right now
While inflation continues to threaten the U.S. economy, it has an indirect but positive impact on the nation’s currency. The Federal Reserve is hiking interest rates rapidly in an attempt to quell inflation. Higher interest rates tend to increase the value of domestic currency, which is exactly what we’re seeing right now.
In inflationary and recession-adjacent periods, investors tend to hedge their bets with dollar-based investments. In turn, this strengthens the dollar.
The effect of a strong dollar on global economies
A strong dollar is great news for Americans embarking on international travel. Combined with America’s record-high inflation, international vacations are no longer at a premium compared to domestic travels. Domestically, this strength has both good and bad elements to it. For one, the U.S. loses out on earnings it gets from other currencies. It can feed inflation, but it can also improve economic circumstances for Americans.
Since the dollar is the leading currency in global reserves, it also positively impacts other nations and can serve as a hedge against their own currencies.
The effect of a strong dollar on the U.S. stock market
Economies and stock markets are not mutually exclusive, but the dollar’s strength does impact them differently.
The U.S. stock market has a history of rising when the dollar is strong. Dollar bull market (or period of time when U.S. currency is strong) tends to lead to stock market performance doubling compared to dollar bear markets (or times when the U.S. currency is weak).
At times when the dollar appreciated more than 10 percent during a year, the stock market posted gains the following year. This trend is consistent with historical data beginning in 1980.
That's not to say there aren't potential downsides. The stock market could experience a bubble, which must inevitably burst.
According to a Reuters poll of 48 forex market analysts, more than three quarters of respondents expect the dollar to continue to rise for at least another quarter. Many of them believe the trend will continue for 6–12 months or longer.