The End of the U.S. Dollar’s Bull Run?

Summary

Podcast Summary: Thoughts on the Market – "The End of the U.S. Dollar’s Bull Run?"

Published on July 16, 2025, by Morgan Stanley

In the July 16, 2025 episode of Thoughts on the Market, hosted by Paul Walsh, Morgan Stanley delves into the evolving dynamics of the U.S. Dollar's performance and its far-reaching implications for the European stock market. Featuring insights from Marina Zavolok, Chief European Equity Strategist, and James Lord, Chief Global FX Strategist, the discussion unpacks the structural shifts in currency strength and corporate hedging strategies amidst a changing economic landscape.

1. The Declining Trajectory of the U.S. Dollar

The episode opens with Paul Walsh addressing the unexpected persistence of the U.S. Dollar's weakness throughout the year, defying the earlier bullish consensus. James Lord elaborates on this shift, highlighting that contrary to the initial expectations of continued U.S. Exceptionalism under the Trump administration—which projected robust growth, capital inflows, and a strengthening dollar—several factors have altered this trajectory.

James explains, “[From 2010 all the way through to the end of last year. The dollar has been on a tear.]” ([02:49]).

He attributes the dollar's structural decline to a combination of slowing U.S. growth projected through 2025 and 2026, restrictive immigration policies, insufficient fiscal stimulus, and escalating trade tariff uncertainties, particularly concerning Section 899. Additionally, the anticipation of the Federal Reserve cutting rates to 2.5% is expected to further weaken the dollar. James emphasizes that the dollar’s 15-year bull run is now facing a significant downturn, leading to profound macroeconomic implications.

2. Impact on the European Stock Market

Marina Zavolok takes the conversation forward by analyzing how the weakening U.S. Dollar intertwines with the European stock market's performance. Transitioning from her background in emerging markets to European equities, Marina notes a surprising underestimation of FX's role in European markets.

She states, “[Different types of hedging policies that you have for those particularly you have hedging for transactional FX mismatches.]” ([04:27])

Marina outlines a comprehensive framework developed to assess FX exposure across various stocks and sectors. Her analysis reveals that while a small segment of the European index benefits from Euro strength—experiencing significant outperformance—the majority faces challenges. Specifically, over half of the European index is adversely affected by Euro and other local currency strength, particularly impacting companies with substantial dollar or emerging market exposures.

Key sectors such as Utilities, Real Estate, and Banks showcase positive exposure and are outperforming the broader European index, a trend Marina anticipates will continue into the upcoming earnings season. Conversely, companies with heavy FX mismatches are likely to encounter earnings downgrades, posing risks to their financial performance.

3. Corporate Hedging Strategies in a Weakening Dollar Environment

The discussion shifts to corporate responses, focusing on hedging strategies employed to mitigate currency risk. Marina highlights that approximately half of the European index faces some level of FX mismatches, encompassing intra-European currency differences and exposures from sourcing goods from regions like Asia or China.

She points out, “[Companies that have advanced hedging FX hedging programs, they first of all, they tend to outperform when you compare them to companies with limited or no hedging despite having transactional mismatches.]” ([08:49])

Marina's analysis underscores that companies with sophisticated hedging programs not only outperform their less-hedged counterparts but also exhibit lower share price volatility. This observation suggests that proactive FX management is not merely a risk mitigation tool but also a potential source of alpha.

James Lord builds on this by discussing tactical adjustments companies can make in their hedging approaches. He advises that corporations consider altering hedge ratios and timing, as well as diversifying the instruments used—from spot and forward markets to various option strategies—to better align with the current market environment. James recommends reviewing their colleague Dave Adams’ report for detailed strategies tailored to different market conditions.

4. European Earnings and the FX Translation Effect

Marina Zavolok concludes with a critical examination of European earnings growth, contrasting local currency results with dollar-denominated figures. She observes that while European earnings growth in local currency is stagnating near 1%, potentially tipping into negative territory by the end of the earnings season, the situation is markedly different when viewed in dollar terms.

She explains, “[European earnings growth now on consensus estimates for this year is approaching 1%. So close to 1% on the back of the moves we've already seen in FX, we're probably going to go negative by the time this earnings season is over in local currency terms. But based on our analysis, that is primarily impacted by translation.]” ([10:43])

Marina emphasizes that in dollar terms, European earnings are robust, growing at 7.6%. This disparity underscores the importance for investors to consider constant currency or dollar-based metrics when evaluating European growth, as relying solely on local currency figures may present a skewed perspective influenced heavily by FX fluctuations.

5. Conclusion: Navigating the Currency Landscape

Paul Walsh wraps up the episode by acknowledging the complexity of the topics discussed and the immediate impact expected in the forthcoming earnings quarter. He commends Marina and James for elucidating the multifaceted relationship between currency dynamics and market performance.

The episode underscores a pivotal shift in the U.S. Dollar’s dominance and the cascading effects on European markets and corporate financial strategies. As the U.S. Dollar's structural decline continues, European companies and investors must navigate a landscape where FX exposure and hedging strategies play increasingly critical roles in financial performance and market positioning.

Listeners are encouraged to engage with future episodes of Thoughts on the Market for continued insights into the evolving global financial landscape.

Transcript

[Paul Walsh]

Welcome to Thoughts on the Market. I'm Paul Walsh, Morgan Stanley's head of European product. And today we're discussing the weakness we've seen year to date in the US Dollar and what this means for the European stock market. It's Tuesday, July 15, at 3pm in London. I'm delighted to be joined by my colleagues Marina Zavolock, Morgan Stanley's chief European equity strategist, and James Lord, Morgan Stanley's chief global FX strategist. James, I'm going to start with you because I think we've got a really differentiated view here on the US Dollar. And I think when we started the year, the bearish view that we had as a house on the US Dollar I don't think many would have agreed with, frankly. And yet here we are today and we've seen the US Dollar weakness proliferating so far this year. But actually, it's more than that. When I listen to your view and the team's view, it sounds like we've got a much more structurally bearish outlook on the US Dollar from here, which has got some tenure. So I don't want to steal your thunder, but why don't you tell us, kind of frame the debate for us around the US Dollar and what you're thinking.

[James Lord]

So at the beginning of the year, you're right, the consensus was that the election of Donald Trump was going to deliver another period of what people have called US Exceptionalism. And with that, it would have been outperformance of US equities, outperformance of US Growth, continued capital inflows into the United States, and outperformance of the US Dollar. At the time, we had a slightly different view. I mean, with the help of the team, we took the other side of that debate largely on the assumption that actually US growth was quite likely to slow through 2025 and probably into 2026 as well, on the back of restrictions on immigration, lack of fiscal stimulus, and increasingly as trade tariffs were going to be implemented, that was going to be something that weighed on growth. So that was how we set out the beginning of the year. And as the year has progressed, the story has evolved. Some of the other things that have happened around just the extent to which TAR tariff uncertainty has escalated the Section 899 debate, some of the softness in the data and just the huge amounts of uncertainty that surrounds US Policymaking in general has accelerated the decline in the US Dollar. So we do think that this has got further to go. I mean, the targets that we set at the beginning of the year we kind of already met them but when we published our mid year outlook we extended the target. So we may even have to go towards the bull case target of euro dollar of 130. But as the US data slows and the it clearly kicks off where Morgan Stanley US Economics Research is expecting the Fed to ultimately cut to two and a half percent. That's going to really weigh on the dollar as well. And this comes on the back of a 15 year bull market for the dollar. From 2010 all the way through to the end of last year. The dollar has been on a tear.

[Paul Walsh]

On a structural bull run.

[James Lord]

Absolutely. And was at the upper end of that long term historical range. And the US has got 4% GDP current account deficit. In a slowing growth environment, it's going to be tough for the dollar to keep going up. And so we think of not in the early stages, maybe sort of halfway through this dollar decline, but it's a huge change compared to what we've been used to. So it's going to have big implications for macro, for companies, for all sorts of people.

[Paul Walsh]

Yeah, and I think that last point you make is absolutely critical in terms of the implications for corporates in particular, Marina. Because that's what we spend every hour of every working day thinking about. And yes, currency has been on the radar, I get that. But I think this structural dynamic that James alludes to perhaps is not really conventional wisdom still when think about the sector analysts and how clients are thinking about the outlook for the US dollar. But the good news is that you've obviously done detailed work in collaboration with the floor to understand the complexities of how this bearish dollar view is percolating across the different stocks and sectors. So I wondered if you could walk us through what your observations are and what your conclusions are. Having done the work, first of all.

[Marina Zavolok]

I just want to acknowledge that what you just said there, my background is emerging markets and coming into covering Europe about a year and a half ago, I've been surprised, especially amid the really big, you know, shift that we're seeing that James was highlighting how FX has been kind of this secondary consideration. In the process of doing this work, I realized that analysts all look at effects in different way, investors all look at affects in different way.

[Paul Walsh]

And, and so do corporates.

[Marina Zavolok]

Yeah, corporates all look at effects in different way. We've looked a lot at that. Having that EM background where we used to think about F as much as we thought about equities, it was as fundamental to the story.

[Paul Walsh]

And to be clear that's because of the volatility.

[Marina Zavolok]

Exactly. Which we're now seeing now coming into global markets effectively with the dollar moves that we've had. What we've done is created or attempted to create a framework for assessing FX exposure by stock, the level of FX mismatches, the types of FX mismatches and the various types of hedging policies that you have for those particularly you have hedging for transactional FX mismatches. And we've looked at this from stock level, sector level, aggregating the stock level data and country level. And basically overall, some of the key conclusions are that the list of stocks that benefit from euro strength that we've identified, which is actually a small pocket of the European index, that group of stocks that actually benefits from euro strength has been strongly outperforming the European index, especially year to date. And just every day it kind of keeps breaking on a relative basis to new highs. Given the backdrop of James's view there, we expect that to continue. On the other hand, you have even more exposure within the European Index of companies that are being hit basically with earnings downgrades and local currency terms that into this earnings season in particular, we expect that to continue to be a risk for local currency earnings. The stocks that are most negatively impacted, they tend to have a lot of dollar exposure or EM exposure where you have pockets of currency weakness as well. So overall what we found through our analysis is that more than half of the European index is negatively exposed to this euro and other local currency strength. The sectors that are positively exposed is a minority of the index. So about 30% is either materially or positively exposed to the euro and local currency strength and sectors within that in particular that stand out positively exposed. Utilities, real estate, banks and the companies in this bucket which we spend a lot of time identifying, they are strongly outperforming the index. They're breaking to new highs almost on a daily basis relative to the index. And I think that's going to continue into earning season because that's going to be one of the standouts positively amid probably a lot of downgrades for companies who have translational exposure to the US or em.

[Paul Walsh]

And so let's take that one step further, Marina, because obviously hedging is an important part of the process for companies. And as we've heard from James, we're in a 15 year bull run for dollar strength. And so most companies would have been hedging dollar strength, to be fair, where they've got mismatches. But what are your observations having looked at the hedging side of the equation.

[Marina Zavolok]

Yeah. So let me start with FX mismatches. So we find that about half of the European index is exposed to some level of FX mismatches. So you have intra European currency mismatches, you have companies sourcing goods in Asia or China and shipping them to Europe. So it's actually a favorable FX mismatch. And then as far as hedging, the type of hedging that tends to happen for companies is related to transactional mismatches. So these are cost revenue, balance sheet mismatches, cash flow distribution type mismatches. So they're more the types of mismatches that could create risk rather than translational mismatches, which are they're just going to happen. And one of the most interesting aspects of our report is that we found that companies that have advanced hedging FX hedging programs, they first of all, they tend to outperform when you compare them to companies with limited or no hedging despite having transactional mismatches. And secondly, they tend to have lower share price volatility as well, particularly versus the companies with no hedging which have the most share price volatility. So the analysis generally in Europe of this most, the most probably diversified region globally is that FX hedging actually does generate alpha and contributes to relative performance.

[Paul Walsh]

Let's connect the two a little bit here now, James, because obviously as companies start to recalibrate for a world where dollar weakness might proliferate for long, those hedging strategies are going to have to change. So just any kind of insights you can give us from that perspective and maybe implications across currency markets as a result of how those behavioral changes might play out, I think would be very interesting for our listeners.

[James Lord]

Yeah, I think one thing that companies can do is change some of the tactics around how they implement the hedges. So this can revolve around both the timing and also the full extent of the hedge ratios that they have. I mean, some companies are in our conversations with them when they're talking about their hedging policy. They may have a range. Maybe they don't hedge a 100% of the risk that they're trying to hedge. They might have to do something between 80 and 100%. So you can adjust your hedge ratios.

[Paul Walsh]

Adjust the balances a bit.

[James Lord]

Yeah. And you can delay the timing of them as well. The other side of it is just deciding exactly what kind of instrument to use to hedge as well. I mean, you can hedge just using pure spot markets. You can use forward markets and currencies, you can implement different types of option strategies. And I think this was some of the information that we were trying to glean from the survey was this question that Marina was asking about, do you have a limited or advanced hedging program? Typically we would find that corporates that have advanced programs might be using more options based strategies, for example. And one of the pieces of analysis in the report that my colleague Dave Adams did was really looking at the effectiveness of different strategies depending on the market environment that we're in. So are we in a sort of risk averse market environment, high volume environment? Different types of strategies work for different types of market environments. So I would encourage all corporates that are thinking about implementing some kind of hedging strategy to have a look at that document because it provides a lot of information about the different ways you can implement your hedges and some are much more cost effective than others.

[Paul Walsh]

Marina, last thought from you.

[Marina Zavolok]

I just want to say overall for Europe there is this kind of story about Europe has no growth, which we've heard for many years. And it's sort of true. It is true in local currency terms. So European earnings growth now on consensus estimates for this year is approaching 1%. So close to 1% on the back of the moves we've already seen in effects, we're probably going to go negative by the time this earnings season is over in local currency terms. But based on our analysis, that is primarily impacted by translation. So it is just because Europe has a lot of exposure to the US it has some EM exposure. So I would just really emphasize here that for investors, so investors, many of which don't hedge fx, when you're comparing Europe growth to the US it's probably better to look in dollar terms or at least in constant currency terms. And in dollar terms, European earnings growth at this point are 7.6% in dollar terms. That's giving Europe the benefit for the Euro exposure that it has in other local currencies. So I think these things as FX starts to be front of mind for investors more and more, these things will become more common focus points. But right now a lot of investors just compare local currency earnings growth.

[Paul Walsh]

So this is not a straightforward topic and we obviously think this is a very important theme moving through the balance of this year. But clearly you're going to see some immediate impact moving through the next quarter of earnings. Marina and James, thanks as always for helping us make some sense of it all.

[James Lord]

Thanks Paul.

[Marina Zavolok]

Thank you.

[Paul Walsh]

And to our listeners out there, thank you as always for tuning in. If you enjoy thoughts on the market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

[Marina Zavolok]

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 and may not be suitable for you.