The Dollar and U.S. Stocks - The Relationship
The U.S. dollar is the world's reserve currency, the denomination of roughly 60% of global foreign exchange reserves, the settlement currency for most international commodity transactions, and the currency in which American corporate earnings are reported. Its value relative to other currencies affects the revenue and profits of every U.S. multinational, the competitiveness of American exports, the cost of imported goods, and the attractiveness of U.S. assets to foreign investors. The relationship between the dollar and U.S. stocks is multifaceted, and it does not operate in a single direction.
Measuring the Dollar
The dollar's "strength" or "weakness" is measured against a basket of other currencies using an index. The most commonly referenced is the DXY, or U.S. Dollar Index, which measures the dollar against six major currencies: the euro (57.6% weight), Japanese yen (13.6%), British pound (11.9%), Canadian dollar (9.1%), Swedish krona (4.2%), and Swiss franc (3.6%).
The DXY was set at 100 when it was introduced in 1973. It has ranged from a low of roughly 71 (in 2008) to a high of roughly 164 (in 1985). As of recent years, it has traded in the 100 to 115 range.
A rising DXY means the dollar is strengthening against these currencies. A falling DXY means it is weakening. The index is heavily euro-weighted, so movements in the EUR/USD exchange rate dominate the DXY.
Other dollar indices exist. The Federal Reserve publishes a broader trade-weighted dollar index that includes currencies of all major U.S. trading partners, including the Chinese yuan, Mexican peso, and Korean won. This index is more representative of the dollar's trade-weighted value but is less commonly cited in financial media.
How the Dollar Affects Corporate Earnings
S&P 500 companies derive approximately 40% of their revenue from international markets. For these companies, a stronger dollar reduces the dollar value of foreign-earned revenue, while a weaker dollar increases it.
The math is direct. If a company earns €100 million in European revenue and the exchange rate moves from $1.10/€ to $1.00/€ (dollar strengthening), that €100 million translates to $100 million instead of $110 million, a $10 million decline with no change in actual business performance. Across the entire S&P 500, a 10% dollar appreciation reduces aggregate earnings by roughly 3% to 5%, according to estimates by Goldman Sachs and other research firms.
The impact is not uniform across companies or sectors.
High international exposure. Technology companies have the highest international revenue shares. Microsoft generates roughly 50% of revenue outside the U.S. Nvidia, Apple, and Alphabet are similarly exposed. A strong dollar is a meaningful headwind for these companies' reported earnings. During earnings calls, management teams frequently reference currency impacts: "constant currency revenue grew 15%, while reported revenue grew 10% due to a 5-percentage-point currency headwind."
Low international exposure. Companies focused on the domestic U.S. market are largely insulated from direct dollar effects. Regional banks, domestic utilities, U.S.-focused retailers (Dollar General, AutoZone), and homebuilders derive the vast majority of revenue in dollars from U.S. customers.
Commodity exporters. U.S. companies that export commodities priced in dollars (agriculture, certain metals) face indirect effects. A strong dollar makes U.S. commodities more expensive for foreign buyers, potentially reducing demand and prices.
Commodity importers. Companies that import raw materials priced in dollars (most commodities are dollar-denominated globally) are less affected by dollar movements since both their costs and their revenue are in dollars.
The Dollar and Sector Performance
The dollar's impact creates clear sector tilts in the stock market.
During periods of dollar strength:
- Technology underperforms relative to sectors with domestic focus, as currency translation reduces reported earnings.
- Domestic-oriented sectors outperform. Small-cap stocks (Russell 2000), which have minimal international revenue, tend to outperform large-cap multinationals during dollar strength.
- Financials benefit modestly from a strong dollar through increased foreign capital flows into U.S. dollar-denominated assets.
- Consumer staples are mixed. Companies like Coca-Cola and Procter & Gamble have enormous international operations, creating currency headwinds, but their pricing power often allows them to offset some of the impact over time.
During periods of dollar weakness:
- Large-cap multinationals benefit as foreign revenue translates into more dollars.
- Materials and industrials benefit from improved export competitiveness and higher dollar-denominated revenue from international projects.
- Emerging market-exposed companies benefit as a weaker dollar eases financial conditions in emerging markets (many of which have dollar-denominated debt), supporting economic activity in those regions.
The Dollar and Capital Flows
The dollar's value influences the flow of international capital into and out of U.S. financial markets.
Foreign buying. When the dollar is expected to strengthen, foreign investors are attracted to U.S. assets because they anticipate currency gains on top of investment returns. A European investor buying U.S. stocks when the dollar is weak can profit from both stock appreciation and dollar appreciation when they convert back to euros. This foreign demand supports U.S. stock prices.
Foreign selling. When the dollar is expected to weaken, U.S. assets become less attractive to foreign investors. The expected currency depreciation reduces the total return in their home currency. Reduced foreign demand can weigh on U.S. stock prices.
The scale of foreign investment in U.S. equities is substantial. Foreign investors hold roughly $14 trillion in U.S. equities and $8 trillion in U.S. Treasuries. Shifts in their willingness to hold dollar-denominated assets can produce meaningful effects on both currency and equity markets.
Dollar as a safe haven. During periods of global financial stress, the dollar typically strengthens as investors worldwide move capital into the perceived safety of U.S. Treasury securities. This "flight to safety" bid for the dollar has been a consistent pattern during crises, including 2008-2009, March 2020, and the European debt crisis of 2011-2012.
The paradox: during financial crises, the dollar strengthens (because of safe-haven flows) while U.S. stocks decline (because of risk aversion). This means the dollar and stocks move in opposite directions during acute stress, a pattern that has repeated across multiple crises.
The Dollar and Monetary Policy
The dollar's value is closely tied to interest rate differentials between the United States and other major economies.
When the Federal Reserve raises rates while other central banks hold steady or cut, the interest rate differential widens in favor of the dollar. International investors can earn higher yields on dollar deposits and Treasuries, increasing demand for dollars and driving the currency higher. The aggressive Fed rate hikes of 2022-2023, combined with relatively accommodative policy from the European Central Bank and Bank of Japan, drove the DXY to a 20-year high above 114 in September 2022.
The reverse dynamic applies when the Fed cuts rates. Lower U.S. rates reduce the yield advantage of dollar assets, weakening the currency. Expectations of Fed rate cuts in late 2023 and 2024 contributed to dollar weakness from the September 2022 peak.
This creates a transmission chain from Fed policy to the dollar to corporate earnings:
Fed raises rates → dollar strengthens → U.S. multinational earnings face currency headwind → stock prices adjust
Fed cuts rates → dollar weakens → U.S. multinational earnings get currency tailwind → stock prices adjust
The lag between policy changes and their effects on corporate earnings is typically two to four quarters, as companies report results that reflect exchange rates from the prior period.
The Dollar Smile
Economist Stephen Jen proposed the "Dollar Smile" theory, which describes two conditions under which the dollar strengthens:
Left side of the smile: The dollar strengthens during global crises and risk aversion, as investors flee to the safety of U.S. Treasuries.
Right side of the smile: The dollar strengthens when the U.S. economy is outperforming the rest of the world, attracting capital flows based on superior growth and higher yields.
Bottom of the smile: The dollar weakens when global growth is synchronized and positive, which reduces the relative attractiveness of U.S. safe-haven assets and encourages capital flows to higher-growth emerging markets.
This framework helps explain why the dollar-stock relationship is not consistently positive or negative. During right-side-of-the-smile periods (U.S. outperformance), a strong dollar coincides with strong U.S. stocks. During left-side-of-the-smile periods (global crisis), a strong dollar coincides with weak stocks. The context matters as much as the direction.
Hedging and Corporate Strategy
Multinational corporations actively manage currency risk. Most large companies use forward contracts, options, and natural hedges (matching foreign currency revenue with foreign currency costs) to reduce the earnings volatility from exchange rate movements.
Apple, for example, regularly adjusts international product pricing to offset currency movements. Microsoft hedges a significant portion of its anticipated foreign currency revenue. These hedging programs smooth the impact but do not eliminate it entirely, and they create timing differences between when exchange rates move and when the impact hits reported earnings.
Investors should examine currency exposure in the context of their overall portfolio. A portfolio concentrated in large-cap U.S. multinationals already has significant implicit exposure to dollar weakness (beneficial) and dollar strength (detrimental). Adding international stocks or international ETFs increases this currency sensitivity further.
The dollar is not a variable that equity investors can control. It is driven by relative monetary policies, relative economic growth, global risk appetite, and trade flows, none of which are predictable with consistency. But understanding how dollar movements flow through to corporate earnings, sector performance, and international capital flows provides context for interpreting market behavior that otherwise appears random. When the market rallies on a weak dollar or sells off on a strong one, the earnings transmission mechanism is usually the explanation.
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