How a Weaker Dollar Could Boost U.S. Stocks

Summary

Thoughts on the Market: How a Weaker Dollar Could Boost U.S. Stocks

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Description: Short, thoughtful, and regular takes on recent events in the markets from a variety of perspectives and voices within Morgan Stanley.
• Episode: How a Weaker Dollar Could Boost U.S. Stocks
• Release Date: July 17, 2025

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Introduction and Morgan Stanley's Bearish Outlook on the Dollar

The episode begins with Michelle Weaver, US Thematic and Equity Strategist at Morgan Stanley, and Dave Adams, Head of G10FX Strategy at Morgan Stanley, setting the stage for an in-depth discussion on the implications of a weakening U.S. dollar on the U.S. equity market. Michelle references a previous discussion on the impact of a weak dollar on European equities and transitions to the current focus.

Michelle Weaver introduces the conversation by stating:

“Morgan Stanley has a bearish view on the US dollar and this is something our chief Global FX strategist James Lord spoke about recently on the show.” [00:09]

Dollar's Performance and Future Outlook

Dave Adams elaborates on Morgan Stanley's bearish stance, highlighting the dollar's significant depreciation over the year. He emphasizes that their outlook remains one of the most pessimistic in the industry.

“We have been dollar bears this whole year and it has been very out of consensus. But we do think the weakness will continue…” [00:44]

Adams notes that the dollar has experienced its worst first half since 1973, with the dollar index dropping approximately 10% year-to-date. He forecasts an additional 10% decline by the end of the next year, attributing this trend to the convergence of U.S. interest and growth rates with those of the rest of the world and increased FX hedging by foreign investors.

Impact of Tariffs on Currency and Federal Policy

Michelle connects the weakening dollar to broader geopolitical trends, specifically the shift towards a multipolar world and the impact of tariffs.

“When I think about one of the key themes that we've been following this year, it's the multipolar world or a shift away from globalization to more localized spheres of influence.” [01:28]

Dave Adams explains how tariffs influence both inflation and U.S. growth:

“Tariffs have a positive impact on inflation but a negative impact on US growth. This puts the Fed in a really tough spot...” [01:49]

He discusses the resulting pressure on the Federal Reserve to maintain a tight monetary policy, which in turn leads to rate convergence globally—another factor contributing to the dollar's decline.

Foreign Investor Hedging Behavior

The conversation shifts to how foreign investors are adapting to the dollar's weakness, particularly through hedging activities.

“Foreign investors own a massive amount of US assets. European investors alone own $8 trillion of US bonds and stocks…” [02:46]

Dave Adams highlights that while many foreign investors have historically not hedged their dollar exposure, there is a growing trend towards increased hedging due to favorable conditions:

“We do think they've started hedging more, but the bulk of the move is really ahead of us.” [02:46]

He estimates that a significant portion of European holdings remains unhedged and anticipates substantial capital flows as hedge ratios increase, potentially amounting to hundreds of billions of dollars.

Implications for U.S. Companies and Earnings

Michelle delves into how a weaker dollar serves as a tailwind for U.S. multinational companies. She explains the "translation effect," where revenue earned in foreign currencies translates to higher dollar amounts when the dollar is weak.

“The weaker dollar is a substantial underappreciated tailwind for US Multinational earnings.” [04:51]

She observes that this positive impact is not widely discussed in earnings calls, as companies typically focus on the challenges posed by a strengthening dollar rather than the benefits of a weakening one.

Benefiting Sectors and Investment Implications

The discussion identifies specific sectors and investment styles that stand to gain the most from a weaker dollar.

Michelle Weaver outlines that large-cap companies with significant international exposure—especially in technology, materials, and industrials—are likely to benefit:

“Tech, materials and industrials have the highest foreign revenue exposure and thus can benefit a lot from that dynamic we've been talking about.” [06:14]

She emphasizes that sectors with high earnings revision sensitivity to the dollar will see the most substantial benefits, making them attractive investment targets.

Conclusion and Investor Advice

In wrapping up, Michelle advises investors to monitor industries and companies that are poised to benefit from the continued weakness of the dollar. She underscores the importance of understanding currency dynamics as a critical driver of earnings and equity performance in a multipolar world.

“As the dollar continues to weaken, investors should keep a close eye on the industries and companies poised to benefit the most...” [07:13]

Dave Adams and Michelle Weaver conclude by reinforcing the strategic importance of these insights for investment decisions, encouraging listeners to incorporate currency trends into their market analysis.

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Key Takeaways:

• Morgan Stanley maintains a highly bearish outlook on the U.S. dollar, predicting a further 10% decline within the next year.
• Tariffs contribute to dollar weakness by increasing inflation and suppressing U.S. growth, leading to potential rate convergence globally.
• Foreign investors are beginning to hedge more against the dollar, which could result in significant capital flows.
• A weaker dollar benefits U.S. multinationals through the translation effect, boosting their earnings from overseas operations.
• Large-cap sectors such as technology, materials, and industrials are the primary beneficiaries of a weaker dollar.
• Investors should focus on industries and companies with substantial foreign revenue exposure to capitalize on the ongoing dollar weakness.

This comprehensive analysis offers valuable insights for investors seeking to navigate the implications of currency fluctuations on the U.S. equity market.

Transcript

[A]

Welcome to Thoughts on the Market. I'm Michelle Weaver, US Thematic and Equity Strategist at Morgan Stanley.

[B]

And I'm Dave Adams, head of G10FX strategy here at Morgan Stanley.

[A]

Our colleagues were recently on the show to talk about the impact of the weak dollar on European equities. And today we wanted to continue that conversation by looking at what a weak US dollar means for the US equity market. It's Thursday, July 17th at 2pm in London. Morgan Stanley has a bearish view on the US dollar and this is something our chief Global FX strategist James Lord spoke about recently on the show. But Dave, I want to go over the outlook again since Morgan Stanley has a really differentiated view on this. Do you think the dollar will continue to depreciate during the remainder of the year?

[B]

We do, and we do. We have been dollar bears this whole year and it has been very out of consensus. But we do think the weakness will continue and our forecasts remain one of the most bearish on the street for the dollar. Yeah, the the dollar has had its worst first half of the year since 1973 and the dollar index has fallen about 10% year to date. But we think we're at the intermission rather than the finale. The second act for the dollar weakening trend should come over the next 12 months as U.S. interest rates and U.S. growth rates converge to that of the rest of the world. And FX hedging of existing US assets held by foreign investors adds further negative risk premium to the dollar. The result is that we're looking for yet another 10% drop in the dollar by the end of next year.

[A]

That's really interesting and a differentiated view for Morgan Stanley. When I think about one of the key themes that we've been following this year, it's the multipolar world or a shift away from globalization to more localized spheres of influence. This is an important element to the dollar story. How have tariffs impacted currency and your outlook?

[B]

Tariffs play a key role in this framework. Tariffs have a positive impact on inflation but a negative impact on US growth. But the inflation impact comes faster and the negative impact on growth and employment that comes a bit later. This puts the Fed in a really tough spot and it's why our economists are pretty out of consensus in calling for both no cuts this year and a much faster and deeper pace of cuts in 2026. The results for me in FX Land is that the market is underestimating just how low the Fed will go and just how low US rates will go. In general, tariffs play a big role in helping to generate this rate convergence. And rate differentials are a fundamental driver of currencies. The more that US rates are gonna fall, the more likely it is that the dollar keeps falling too.

[A]

Tariffs have certainly impacted heavily on our view for the U.S. equity market. And it's something that no asset class is not impacted by, really, given the volatility and the magnitude of the move we've seen this year. Are foreign investors hedging more?

[B]

We do think they've started hedging more, but the bulk of the move is really ahead of us. Foreign investors own a massive amount of US assets. European investors alone own $8 trillion of US bonds and stocks. And that's only about a quarter of total foreign ownership of US assets. Now, when foreign investors buy US assets, they have to sell their currency and buy the dollar. But at some point you're going to have to bring that money back, so you're going to have to sell the dollar and buy currency again. If the dollar rises over this period, you've made a gain, congratulations. But if it falls, you've made a loss. Now, a lot of foreign investors will hedge this currency risk and they'll use instruments like forwards and options to do so. But in the case of the US we found that a lot of informed investors really choose not to hedge this exposure, particularly on the equity side. And this reflects both a view that the dollar would appreciate, so they want to take that gain, but it also reflects the dollar's negative correlation to equities. So what's changing now? Well, a lot of investors are starting to rethink this decision and add those hedges, which really means dollar selling. Now, there's a lot of factors motivating their decision to hedge. One, of course, is price. If US rates are going to converge meaningfully to the rest of the world like we expect, that flattens out the forward curve and makes those forwards cheaper to buy to hedge. But the breakdown in correlations that we've seen more broadly, the uptick in policy volatility and uncertainty, and the sell off in the dollar that we've already seen year to date have all increased the relative benefit of FX hedging. Now, Michelle, I often get asked the question, that's a nice story, but is hedging actually picking up? And the answer is yes. The initial data suggests that hedging has picked up in the second quarter. But because of the size of US asset holdings and given how much it was initially unhedged, we could be talking about a significant long term flow. We have a lot more to Go from here.

[A]

Yeah.

[B]

We estimated that just over half of Europe's $8 trillion holdings are unhedged. And if hedge ratios pick up even a little bit, we could be talking about hundreds of billions of dollars in flow. And that's just from Europe. But, Michelle, I wanted to ask you, what do you think a weaker dollar means for US Companies?

[A]

The weaker dollar is a substantial underappreciated tailwind for US Multinational earnings. And this is because these companies sell products overseas and then get paid in foreign currency. So when the dollar's down, converting that foreign revenue back into dollars gives them a nice boost, something that domestic only companies aren't going to benefit from. And this is called the translation effect. Recently we've seen earnings revisions breadth, essentially a measure of whether analysts are getting more optimistic or pessimistic, start to turn up after hitting typical cycle lows. And based on our house view for the dollar, there's likely more upside ahead based on that relationship for revisions over the next year.

[B]

Interesting, interesting. And is this something you're hearing about from companies on things like earnings calls?

[A]

No. This dynamic isn't being highlighted much on earnings calls. Typically, companies talk about foreign exchange effects when the dollar is strengthening and provides a headwind for corporate earnings. But when we're in the reverse scenario, like we are now, with the dollar weakening and getting a boost to earnings, we tend to not hear as much discussion, which is why I called this an underappreciated tailwind. And according to your team's forecast, we still have a substantial amount of weakening to go and thus a substantial amount of benefit for US Companies to go.

[B]

Yeah, that makes sense. And who do you think benefits most from this dynamic? Are there any sectors or investment styles that look particularly good here?

[A]

So generally, it's the large cap companies that stand to gain the most from this dynamic, and that's because they do more business overseas. If we look at foreign revenue exposure for different indices, around 40% of the S&P 500's revenue comes from outside the US while that's just 22% for the Russell 2000 small cap index. But the impact of a weaker dollar isn't the same across the board. Foreign revenue exposure and earnings revision sensitivity to the dollar vary quite a bit when we look at the sector and the industry group level from a foreign revenue exposure perspective, tech materials and industrials have the highest foreign revenue exposure and thus can benefit a lot from that dynamic we've been talking about. When we look from an earnings revisions perspective, capital goods, materials, software and tech hardware have the most earnings revisions sensitivity to a weaker dollar so they could also benefit there.

[B]

So I guess this brings us to the million dollar question that all of our listeners are asking. What do we do with this information? What does this mean for investors?

[A]

So as the dollar continues to weaken, investors should keep a close eye on the industries and companies poised to benefit the most because in this multipolar world currency dynamics are not just a macro backdrop but an important driver of earnings and equity performance. Dave, thank you for taking the time to talk and to our listeners, thanks for listening. If you enjoy thoughts on the market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today. The preceding content is informational only and based on information available when created. It is not an offer or solicitation nor is it tax or legal advice. It does not consider your financial circumstances and objectives may not be suitable for you.