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Market volatility is nothing new this year. After a summer rebound, equities have headed south, and interest rates are back on the rise as a redux of what we experienced during the second quarter. Big swings in the currency markets cannot go unnoticed either. If you, like many Americans, traveled overseas during the last few months, you surely found items priced in euros were less expensive.

The euro and yen: Worrisome signs

The euro is now about even with the U.S. dollar (USD) – the first time in 20 years. Meanwhile, the Japanese yen’s (JPY) value compared to the greenback has also fallen off a cliff. Traders commonly look to the “USD/JPY” currency relationship as a gauge of global market health. In this case, big moves in 2022 cast an ominous shadow. USD/JPY went from near a stable 100 yen for every dollar at the end of 2020 to a 24-year high of 144 (a steep depreciation of the yen) in recent days. More broadly, the U.S. Dollar Index (DXY), a macroeconomic measure of the greenback’s strength relative to all trade-weighted currencies, shot to fresh 20-year highs this week.

Chart titled A Flight to Safety in the Greenback. U.S. Dollar Index climbs to 20-year Highs. Chart dates from September 1999 to September 2022 the U.S. Dollar index begins to rise in 1999 from 100 to 120 in September 2002, then begins to drop in 2003 until September 2008 where it bottoms around 75 before slowly climbing. Source: Ally Invest, Yahoo Finance.

The dollar roars

A perfect storm of events brought about a surging dollar starting in May of 2021. Two huge drivers are the deepening energy crisis around the world and international monetary policy differences. Economic turmoil and inflation stoked by skyrocketing natural gas (LNG), coal, and power costs have been a big player in the euro’s 2022 fall over the last 16 months. The ongoing conflict in Ukraine made the euro vulnerable. Moreover, the European Central Bank (ECB) is slower to hike interest rates compared to the U.S. Federal Reserve’s (the Fed) hawkish policy and action. That interest rate differential leads money to flee Europe for higher-yielding U.S Treasury securities.

Tough times in Japan

We can’t ignore what’s happening in Japan. With USD/JPY surging, indicative of a depreciating yen, the world’s third-largest economy is in a perilous position of its own. Like much of eastern Europe, Japan is dependent on imports of LNG for power generation. Following the Fukushima disaster in 2011, the nation moved away from nuclear power and toward natural gas-fired generation. Also like in Europe, very low interest rates in Japan make holding its bonds less attractive than holding U.S. Treasuries.

Keeping currency moves in context

Let’s take off our economist hats and bring this topic home for investors. A strong dollar sounds great, but it adds pressure to an economy that faces enough headwinds as is. The upshot is that the more the dollar rises, the less ‘pain’ the Fed must inflict – it’s as if the market is doing Chair Powell’s tightening work for him. A higher dollar generally curbs net exports, reducing U.S. GDP and it dings corporate profits for firms that earn some revenue abroad. Which is what the Fed is aiming for – lower economic growth can help to cool inflation. Finally, commodities denominated in dollars often retreat when the U.S. Dollar Index (DXY) rises, and we might finally be seeing that in oil and gasoline prices.

Value among foreign stocks?

For long-term investors, it’s important to recognize that foreign stock and bond funds tend to underperform domestic funds in a rising-dollar environment. But the thing about currency swings is that they are usually just that – swings back and forth. It is a fool’s errand to try to time when the euro or dollar might rise, then go in and out of foreign mutual funds and ETFs. The better strategy is to stick with your investment plan and maybe even take advantage of big drops in diversified international investments. Consider that price-to-earnings ratios in Europe and Japan are in the 11x to 13x range, according to Bloomberg data, lower than the S&P 500’s earnings multiple above 17x.

Chart titled U.S. Stocks Command a High Valuation. International Markets Appear Cheaper. Shows the 2022 P/E Multiple for the following regions; Europe at 11.3 times, Japan at 12.3 times, China at 11.6 times, Emerging Markets at 11.0 times and the U.S. at 17.6 times. Source: Ally Invest, Bloomberg P/E ratios are for the MSCI Index for the labeled regions except for the U.S. which is the P/E of the S&P 500.

The bottom line

Just as students are back in the classroom, investors have gone through a tough “Macroeconomics 101” in markets this year. A soaring dollar is caused by a host of troubling international issues. Crippling energy costs in Europe and Asia, as well as international central bank actions have made other major currencies less attractive compared to the dollar. Investors should not let dramatic headlines steer them away from staying the course with their investing strategies.