Understanding the U.S. Dollar’s Recent Declines and What It Means for International Equity Performance

By Joe Halwax, CAIA, CIMA, Senior Managing Director, Institutional Investment Services. Originally published August 4, 2025, on Wespath.com.

The U.S. dollar has weakened more than 10% in 2025, leading to more questions from Wespath investors about the impact of currency than at any time in my recent memory.

The dollar is vital for U.S. investors due to its influence on investment returns, inflation and market sentiment. This recent decline comes after several years of dollar strength, and it’s directly contributing to this year’s international equity outperformance. With all this in mind, now is a great time to dive into the role of the dollar and other currencies within diversified portfolios.

Why has the dollar weakened in 2025?

Several factors are likely serving as a catalyst for the dollar’s decline this year:

• Strong run: The dollar was trading at historically high levels, with the U.S. dollar index starting 2025 roughly 40% higher than the lows it reached in 2009 and 2011.

• Trade Policy and Tariffs: The April 2 “Liberation Day” tariff announcements were larger and broader than expected, which led to a temporary loss of confidence in the dollar’s safe-haven status. More broadly, the U.S. policy environment has been volatile as the Trump administration attempts major structural shifts.

• Concerns Over U.S. Debt and Fiscal Policy: The U.S. national debt stands at $37 trillion, and the recent spending bill is expected to add additional trillions to it over the next decade. This has raised concerns about the sustainability of U.S. borrowing, leading to an exodus from the U.S. Treasury market, especially on longer maturities.

• Federal Reserve Policy and Interest Rate Expectations: While expectations for fewer rate cuts may have supported a stronger dollar, the public criticism of Fed Chair Jerome Powell has raised questions about the central bank’s independence, weighing on dollar sentiment.

• Global Economic Shifts: The U.S. economy’s growth outlook was downgraded by the OECD from 2.2% to 1.6% for 2025, signaling reduced economic momentum compared to other developed markets. This contrasts with 2024, when U.S. growth of 2.7% outpaced the 1.7% forecast for other developed markets.

Influence on market performance this year

The chart below shows a snapshot of both the U.S dollar and equity market performance this year. Year to date through July 23, 2025, it shows:

• Blue line: U.S. dollar, down 10.7%

• Green line: MSCI All Country World ex-U.S. Index, up 16.2%

• Red line: S&P 500, up 5.4%

(Source: Wespath, FactSet, as of July 23, 2025)

As you can see, international stock outperformance began as the dollar started to weaken in February, which coincided with a rotation out of U.S. mega-cap stocks. Notably, this international outperformance started well before “Liberation Day” and accelerated thereafter.

Looking further back, there has been one other time the dollar has fallen by roughly 10% since 2019. That was between September 2022 and Summer 2023, with the dollar bottoming in July of that year. In that period, international stocks outperformed U.S .stocks by roughly 6%. In 2025, the weaker dollar has been one of the catalysts for international stocks outperforming U.S. stocks by over 10% through Q2.

What is the role of the dollar and foreign currency in globally diversified portfolios for U.S. investors?

Both the U.S. dollar and foreign currencies play an important role in global portfolios due to their impact on diversification and return potential. For starters, for U.S. investors, international equity returns are typically quoted in dollar terms. When the dollar weakens, foreign stocks and bonds in your portfolio gain value in dollar terms, boosting their returns. For example, a 10% drop in the dollar’s value in 2025 increased returns on European stocks by roughly an extra 8% for U.S. investors.

Additionally, foreign currency is bought to purchase securities outside the U.S. Thus, it acts as a diversification tool through exposure to foreign assets. Holding assets in foreign currencies (e.g., Euro, Yen) hedges against dollar volatility, as foreign assets historically perform better when the dollar weakens, offsetting potential losses in U.S. markets. However, a stronger dollar can hurt multinational companies’ earnings and depress commodity prices, impacting your portfolio’s global equity and bond holdings.

What is the outlook for the dollar and its impact on global markets?

As noted earlier, the dollar is 10% lower on the year, but that’s down modestly from very strong levels:

(Source: fred.stlouisfed.org)

Going forward, the structural headwinds which contributed to the dollar’s decline that I noted earlier are likely to still be in place, at least in the near term. But the recent decline far from erases the currency’s multi-year strengthening, and the dollar is unlikely to lose its status as the world’s reserve currency soon. We see several periods of similar, if not slightly longer, declines in the longer view of the dollar index above. I would stop well short of predicting a year-end level for the dollar, just as we don’t predict year-end index returns, but the bottoms the dollar experienced in 2018, 2021 and 2023 will be interesting thresholds to watch for the remainder of the year.

This historical context and long-term perspective are important to keep in mind. There are times when the dollar is less relevant to broad market returns, and there are times like today where it feels like a significant driving factor. We may expect that feeling to persist to some degree until we see some stabilization of the policy and debt conditions identified above.