A Strong U.S. Dollar Changes Everything

Near its highest level since 2009

December 1, 2014 – SAN FRANCISCO–(BUSINESS WIRE)–A new report released by the Schwab Center for Financial Research, a division of Charles Schwab & Co., Inc., examines the implications of a strengthening U.S. dollar, and suggests investors should consider reducing their exposure to international developed-country and emerging market bonds, as well as to commodities.

A Strong U.S. Dollar Changes Everything is the latest whitepaper from Kathy A. Jones, vice president and fixed income strategist with the Schwab Center for Financial Research. The whitepaper analyzes the U.S. dollar’s recent strength in the context of the current global economy and makes a case for why the trend is likely to be sustained over the longer term. Jones says a rising U.S. dollar means that U.S. bonds are likely to outperform international bonds from developed countries and emerging markets, and commodities are expected to underperform.

“The U.S. dollar is near its highest levels since 2009, and has appreciated by more than seven percent since May,” says Jones. “We think this bullish trend is just starting and could last more than a year. That can have significant implications for an investment portfolio, so this is a good time for investors to review their fixed income and commodity allocations and consider making adjustments.”

Key points in the whitepaper include:

  • A key driver behind the U.S. dollar’s strength is the performance of the U.S. economy relative to other major economies around the globe. The International Monetary Fund (IMF) estimates that U.S. GDP will expand 3.1 percent in 2015 compared to estimated growth rates of 1.3 percent and 0.8 percent for the Eurozone and Japan, respectively. With stronger growth, U.S. interest rates are significantly higher than those in core European countries and Japan, making the dollar more attractive for investors to hold. Additional factors supporting the strong U.S. dollar are the declining U.S. current account deficit and the diverging trend between U.S. monetary policy and the policies of other central banks.
  • If the U.S. dollar continues to appreciate, the return on foreign bonds is likely to lag behind the return on U.S. bonds. This is especially true in the developed country bonds, where yields tend to be lower than in the U.S.
  • In addition, a strengthening U.S. dollar is likely to cause commodities to underperform as an asset class. Since most globally traded commodities are traded in U.S. dollars, a stronger dollar tends to send the prices of commodities lower, all else being equal.
    “We think trimming exposure to foreign bonds and commodities to account for a rising dollar makes sense,” says Jones. “That said, there are risks to consider. International bonds offer valuable diversification in an overall portfolio, and reducing holdings in these asset classes may mean giving up some of this benefit.”
...this is a good time for investors to review their fixed income and commodity allocations and consider making adjustments

Jones notes that other factors investors should consider over the next twelve months include an unanticipated shift in the path of the U.S. dollar, a robust rebound in global growth, and a possible change in the Federal Reserve’s timeline for tightening monetary policy.

Investors interested in learning more about investing in a strong U.S. dollar environment can reach out to their Schwab financial consultant or to a Schwab bond specialist.

The full whitepaper, part of Schwab’s Investing Ideas series, is available here.






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