By Tina Fong, Economist Global Economics at Schroders

A sustained decline in the dollar could reshape the outlook for global equity markets. In this paper, one of three on the topic, we examine how a weaker dollar could affect stock markets in the US, UK, Europe, and emerging economies – exploring key drivers, sector sensitivities, and what investors should watch for.

The US dollar has dropped sharply this year, primarily driven by investor uncertainty over Trump’s tariff policies and a reassessment of the appeal of US assets. However, despite the weaker dollar, the S&P 500 has still posted strong gains, in the double digits, thanks to solid domestic growth and strong corporate earnings.

Looking ahead, the extent to which the dollar affects the US stock market will depend on why it’s falling. If the weakness is due to rising budget and trade deficits, and investors shifting away from US assets, this would increase risk premia and hurt valuations.

For markets outside the US, the impact of a weaker dollar will depend on how local policymakers respond. Ultimately, US exceptionalism will be challenged if the dollar continues to weaken.

The changing relationship between the US dollar and US equities

The relationship between the dollar and the stock market has evolved over time, shaped by the broader economy, central bank policies, global trends, and investor sentiment.

Since the 2000s, a weaker dollar has generally been beneficial for US stocks. Globalisation has increased the importance of foreign revenue for US companies. A weaker dollar increases reported earnings because foreign revenues are translated into higher dollar-denominated earnings. A weaker dollar also improves US export competitiveness, supporting the top-line growth of companies.Weaker dollar likely to be a headwind for US equities.

Schroders’ S&P 500 earnings model, which incorporates macro assumptions including global GDP growth, estimates that a 20% dollar decline would boost S&P 500 earnings by approximately 4%. However, this projection assumes that companies continue to earn a large share of their profits from overseas. If Trump’s tariff policies lead businesses to reshore production or curtail international operations, the benefit from a weaker dollar could diminish.

More importantly, if the dollar weakens because investors lose confidence in US assets and are less willing to finance the twin deficits, the result could be a higher risk premium. In practice, this means investors would demand higher returns to hold US Treasuries and stocks. That would push up borrowing costs across the economy and tighten financial conditions, with rising bond yields more than offsetting any competitiveness boost from a weaker currency. 

At the same time, higher bond yields typically result in market de-rating and lower price-to-earnings (PE) multiples because future corporate earnings are discounted at higher rates. Compared to other stock markets, US equities are more sensitive to rising bond yields. This reflects their higher weighting in growth stocks, in sectors such as tech and consumer discretionary, which are more sensitive to rising borrowing costs. This contrasts with financial and energy sectors, which are less sensitive to higher yields.

Euro strength could benefit the more domestic focused companies

When the dollar falls, it usually hurts European company earnings. This occurs as a stronger euro makes European exports less competitive globally. This can reduce sales and profits, especially since many European firms rely heavily on international revenue. Nearly 70% of European companies generate money from outside the region. 

Sectors like technology, consumer staples, and industrials are particularly affected by a weaker dollar. On the other hand, sectors that focus primarily on domestic customers or source materials predominantly within the euro area are likely to perform better in this environment. If the euro is rising because Europe’s economy is doing well or investors are more optimistic about future growth, then the stronger currency may not hurt corporate earnings as much. 

This year, both the euro and European stock markets have rallied, thanks to an improved growth outlook, especially with Germany boosting spending through fiscal stimulus. To help industries that rely heavily on foreign revenues, policymakers might implement supportive measures. But these actions could take time to have an effect, and might not work as intended. Additionally, if governments loosen their budgets to support growth, this could lead to higher long-term borrowing costs through higher risk premia. That could weigh on stock valuations. However, the European market is less sensitive to rising yields. 

Are emerging market equities the main beneficiaries?

A weaker dollar can help emerging markets in several ways. First, it tends to lower global prices for food, energy, and Chinese imports, which helps reduce inflation. This gives central banks in these regions more room to cut interest rates and support local growth.

Second, when the dollar falls, it becomes easier for countries and companies to repay dollar-denominated debt, improving their financial health. If investors rotate capital from US assets into emerging markets, this could lead to stronger capital inflows, which is especially important for regions that rely heavily on foreign investment. Supply-constrained emerging market countries like South Africa, Indonesia, Turkey, and parts of Latin America (LATAM) could benefit from this more favourable environment. 

Conclusion

A weaker dollar has mixed implications for global equity markets. It typically boosts US corporate earnings through improved export competitiveness and foreign revenue translation. But the broader impact on US equities is likely negative if the dollar’s decline reflects waning investor confidence and rising risk premia, which could lift bond yields and weigh on valuations. 

In contrast, emerging markets stand to benefit from disinflationary tailwinds, improved debt dynamics, and stronger capital inflows. While European equities face headwinds due to their high foreign revenue exposure, domestic-focused sectors may offer some resilience. Ultimately, the weaker dollar challenges US exceptionalism and reshapes regional market leadership.

Further reading

• A weaker dollar: how would it play out for global inflation and growth? By David Rees, George Brown and Irene Lauro, economists at Schroders.
  A structural decline in the dollar’s value would have far-reaching implications. In this paper, one of three on the topic, we analyse what a weaker dollar would mean for inflation, growth, and policy responses around the world.
• A weaker US dollar: implications for global equity markets, by Tina Fong, economist at Schroders.
  A sustained decline in the dollar could reshape the outlook for global equity markets. In this paper, one of three on the topic, we examine how a weaker dollar could affect stock markets in the US, UK, Europe, and emerging economies – exploring key drivers, sector sensitivities, and what investors should watch for.
• Currency hedging: navigating the shifting currency correlations with equities and a decline in the dollar, by Caroline Houdri, Fund Manager, and James Pearmund, Solutions Manager, at Schroders.
  Shifting currency correlations with equities have implications for best practice in currency hedging. In this note, one of three in a series considering the impact of a decline in the dollar, we consider how optimal hedging strategies could evolve.