The Great Currency Reversal

May 12, 2025 | Eddie Arrieta, Associate Research Analyst

As a result of policy uncertainty, shifting sentiment, and a potential U.S. economic slowdown, the dollar has moved lower in 2025, amplifying non-U.S. equity returns for domestic investors this year. This week’s chart outlines this dynamic, highlighting the “return differential” between dollar-based and local currency returns for both developed and emerging market indices. The 8.2% differential for the MSCI EAFE Index, which tracks international developed markets, reflects stronger European currencies (e.g., the euro) that have been fueled by positive growth forecasts and increased defense spending (as noted in “Europe on Defense”). These factors have turned modest equity gains in local terms into significant returns for dollar-based investors. Similarly, Japan has seen a stronger yen in recent months. The MSCI Emerging Markets Index has seen a smaller differential than its developed counterpart this year, but U.S. investors have still benefited from currency effects across several emerging countries. The Brazilian real, for instance, has strengthened in 2025 thanks to a 50 basis point rate hike by the nation’s central bank earlier this month, which has attracted increased capital flows. Taiwan has also seen strengthening of its currency in recent days.

While a weaker U.S. dollar has served as a tailwind for domestic investors in non-U.S. equities, risks related to this trend should be noted. For instance, a weaker U.S. dollar can lead to higher import prices, which can exacerbate inflation and reduce the purchasing power of consumers. A weaker greenback can also discourage foreign investment and serve as a signal of a challenged economic environment. Given the current climate and the currency trends detailed above, it is critical that investors remain diversified across both U.S. and non-U.S. markets to reduce exposure to currency-specific risks and enhance portfolio stability amid global economic fluctuations.

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