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Markets in a Minute

Visualized: What Factors Drive the U.S. Dollar?



This infographic is available as a poster.

Visualized: What Factors Drive the U.S. Dollar?

U.S. Dollar

This infographic is available as a poster.

What Factors Drive the U.S. Dollar?

In 2022, the U.S. dollar hit 20-year highs as inflation and interest rates rose sharply.

Not only did investors buy U.S. dollars given its role as the world’s reserve currency, but demand for U.S. dollars increased as rising interest rates drove higher returns for the safe-haven currency.

Now, as inflation appears to be easing and lower rate hikes look to be in the cards, the U.S. dollar is cooling. Still, relative to many of the other major global currencies it remains strong.

In the above Markets in a Minute from New York Life Investments, we look at factors that influence the U.S. dollar’s value, and the implications for financial markets and investors.

What Drives the U.S. Dollar?

Importantly, the value of the U.S. dollar is driven by supply and demand factors. During periods of economic uncertainty, investors turn to U.S. dollars because of the underlying strength of the U.S. economy and its role in global financial markets.

Here is a brief overview of some of the key variables that impact the dollar:

1. Inflation2. Interest Rates3. Safe-Haven Status
4. Economic Growth
High U.S. inflation drives Fed rate hikes.

Higher interest rates mean higher yields for U.S. dollar investors.

Investors turn to U.S. dollars during market turmoil.

Historically, the U.S. has had reliable growth.

When U.S. inflation is increasing, it has knock-on effects on interest rates. As the Federal Reserve raises interest rates to fight inflation, it makes the returns of holding the greenback more attractive. This is because global investors look to currencies that generate a higher relative return, accounting for other factors.

Meanwhile, the dollar remains the global reserve currency. Today, roughly half of global trade invoices are in U.S. dollars. Many global corporations and governments borrow in U.S. dollars, while revenues are generated in their local currency.

Alongside this, the liquidity and depth of U.S. financial markets are unmatched. In 2022, 59% of central bank reserves were held in U.S. dollars, indicating strong demand internationally.

U.S. Dollar Trends Over 50 Years

Since the early 1970s when the U.S. dollar delinked from gold, the currency has had three cycles of strength and three weakening cycles.

These trends can be shown through the U.S. Dollar Index or “Dixie” which tracks the value of the dollar against a basket of weighted currencies.

U.S. Dollar CyclesU.S. Dollar Index PeakYearAnnual Inflation RateAnnual Interest Rate
1990s - 2000s11320021.6%1.7%
2011 - 2020s11420227.1%4.0%

Annual data as of November 2022. Inflation is represented by the Consumer Price Index. Interest rates are represented by the Federal Funds rate.

As the above table shows, the first dollar peak took place in the 1980s as Fed chair Paul Volcker was aggressively hiking interest rates to fight inflation. As interest rates rose, investors flocked to the dollar, pushing it to record highs.

In the second strengthening cycle of the 1990s and 2000s emerging markets were growing at a considerable rate and buying U.S. dollar debt. During this time, a rising dollar hurt emerging market currencies and contributed to the Asian Financial Crisis of the 1990s. Here, currencies with high dollar-denominated debt but low U.S. dollar currency reserves struggled to pay off their debts.

During the Dotcom crash of 2002, the dollar hit its second peak.

The most recent cycle, since 2011, has been the longest strengthening cycle in decades. As the Federal Reserve moved to tighten monetary policy in the mid-2010s, the dollar’s strength accelerated. This has only been more pronounced in 2022 as the Fed hiked rates at the fastest rate in decades.

Weighing the Global Impact

As the below table shows, nearly all major global currencies have declined against the dollar:

CurrencyYTD Performance Against the U.S. Dollar*
Brazilian Real4.7%
Mexican Peso3.2%
Swiss Fanc-2.5%
Australian Dollar-6.9%
Canadian Dollar-7.4%
Chinese Yuan-8.9%
British Pound-9.2%
Swedish Krona-12.3%
Japanese Yen-16.4%

Source: Google Finance (Dec 2022). *Year-to-date performance as of Dec 12, 2022.

The main exceptions are the Brazilian real and Mexican peso. In anticipation of U.S. central bank rate hikes, both countries raised interest rates swiftly, creating higher yields for investors. In addition to being ahead of U.S. rate increases, both countries are energy producers.

By contrast, countries reliant on importing energy have seen weaker currencies. This includes the Japanese yen, Swedish krona, and the British pound. In the case of China, a weaker currency is the impact of a slow economic growth outlook due to its strict zero-COVID-19 strategy and low interest rates.

Europes grim economic prospects driven by the energy crisis have also pushed down the euro, with the currency reaching parity with the dollar in 2022 for the first time in two decades.

Bringing it All Together

Generally speaking, a strong dollar leads to weaker global growth. As U.S. imports get more expensive, it drives up inflation across countries.

When the U.S. dollar is strong it also makes U.S. assets pricier compared to foreign assets, which could impact the direction of capital flows. If the dollar remains strong, capital flows may be redirected away from America.

Finally, in the U.S., a strong dollar could weaken growth and lower inflation, serving as a mixed blessing for investors and consumers alike.

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Markets in a Minute

What is the Success Rate of Actively Managed Funds?

For actively managed funds, the odds of beating the market over the long run are like finding a needle in a haystack.



Actively Managed Funds

What is the Success Rate of Actively Managed Funds?

Over a 20-year period, 95% of large-cap actively managed funds have underperformed their benchmark.

The above graphic shows the performance of actively managed funds across a range of fund types, using data from S&P Global via Charlie Bilello.

Missing the Mark: Actively Managed Funds

Several factors present headwinds to actively managed funds.

  • Trading costs: First, fund managers will trade more often than passive funds. These in turn incur costs, impacting returns.
  • Cash holdings: Additionally, many of these funds hold a cash allocation of about 5% or more to capture market opportunities. Unlike active funds, their passive counterparts are often fully invested. Cash holdings can have the opposite effect than intended—dragging on overall returns.
  • Fees: Active funds can charge up to 1-2% in investment manager fees while funds that tracked an index passively charged just 0.12% on average in 2022. These additional costs add up over time.

Below, we show how active funds increasingly underperform against their benchmark over each time period.

Fund Type1 Year
% Underperformed
5 Year
% Underperformed
10 Year
% Underperformed
20 Year
% Underperformed
All Large-Cap 51879195
All Small-Cap 57718994
Large-Cap Growth 74869698
Large-Cap Value 59698587
Small-Cap Growth 80598597
Small-Cap Value 41819192
Real Estate 88627487

As we can see, 51% of all large-cap active mutual funds underperformed in a one-year period. That compares to 41% of small-cap value funds, which had the best chance of outperforming the benchmark annually. Also, an eye-opening 88% of real estate funds underperformed.

For context, Warren Buffett’s firm Berkshire Hathaway has beat the S&P 500 two-thirds of the time. Even the world’s top stock pickers have a hard time beating the market’s returns.

2020 Market Crash: A Case Study

How about active funds’ performance during a crisis?

While the case for actively managed funds is often stronger during a market downturn, a 2020 study shows how they continued to underperform the index.

Overall, 74% of over 3,600 active funds with $4.9 trillion in assets did worse than the S&P 500 during the 2020 market plunge.

Stage of 2020 CycleTime Period% Underperforming S&P 500
CrisisFeb 20 - Apr 30, 202074.2
CrashFeb 20 - Mar 23, 202063.5
RecoveryMar 24 - Apr 30, 202055.8
Pre-CrisisOct 1 2019 - Jan 31, 202067.1

Source: NBER

In better news, roughly half underperformed through the recovery, the best out of any market condition that was studied.

The Bigger Impact

Of course, some actively managed funds outperform.

Still, choosing the top funds year after year can be challenging. Also note that active fund managers typically only run a portfolio for four and a half years on average before someone new takes over, making it difficult to stick with a star manager for very long.

As lower returns accumulate over time, the impact of investing in active mutual funds can be striking. If an investor had a $100,000 portfolio and paid 2% in costs every year for 25 years, they would lose about $170,000 to fees if it earned 6% annually.

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Markets in a Minute

Ranked: The Largest Bond Markets in the World

The global bond market stands at $133 trillion in value. Here are the major players in bond markets worldwide.



The Largest Bond Markets in the World

The Largest Bond Markets in the World

In 2022, the global bond market totaled $133 trillion.

As one of the world’s largest capital markets, debt securities have grown sevenfold over the last 40 years. Fueling this growth are government and corporate debt sales across major economies and emerging markets. Over the last three years, China’s bond market has grown 13% annually.

Based on estimates from the Bank for International Statements, this graphic shows the largest bond markets in the world.

ℹ️ Total debt numbers here include both domestic and international debt securities in each particular country or region. BIS notes that international debt securities are issued outside the local market of the country where the borrower resides and cover eurobonds as well as foreign bonds, but exclude negotiable loans.

Ranked: The World’s Top Bond Markets

Valued at over $51 trillion, the U.S. has the largest bond market globally.

Government bonds made up the majority of its debt market, with over $26 trillion in securities outstanding. In 2022, the Federal government paid $534 billion in interest on this debt.

China is second, at 16% of the global total. Local commercial banks hold the greatest share of its outstanding bonds, while foreign ownership remains fairly low. Foreign interest in China’s bonds slowed in 2022 amid geopolitical tensions in Ukraine and lower yields.

Bond Market RankCountry / RegionTotal Debt OutstandingShare of Total Bond Market
1🇺🇸 U.S.$51.3T39%
2🇨🇳 China$20.9T16%
3🇯🇵 Japan$11.0T8%
4🇫🇷 France$4.4T3%
5🇬🇧 United Kingdom$4.3T3%
6🇨🇦 Canada$4.0T3%
7🇩🇪 Germany$3.7T3%
8🇮🇹 Italy$2.9T2%
9🇰🇾 Cayman Islands*$2.7T2%
10🇧🇷 Brazil*$2.4T2%
11🇰🇷 South Korea*$2.2T2%
12🇦🇺 Australia$2.2T2%
13🇳🇱 Netherlands$1.9T1%
14🇪🇸 Spain$1.9T1%
15🇮🇳 India*$1.3T1%
16🇮🇪 Ireland$1.0T1%
17🇲🇽 Mexico*$1.0T1%
18🇱🇺 Luxembourg$0.9T1%
19🇧🇪 Belgium$0.7T>1%
20🇷🇺 Russia*$0.7T>1%

*Represent countries where total debt securities were not reported by national authorities. These figures are the sum of domestic debt securities reported by national authorities and/or international debt securities compiled by BIS.
Data as of Q3 2022.

As the above table shows, Japan has the third biggest debt market. Japan’s central bank owns a massive share of its government bonds. Central bank ownership hit a record 50% as it tweaked its yield curve control policy that was introduced in 2016. The policy was designed to help boost inflation and prevent interest rates from falling. As inflation began to rise in 2022 and bond investors began selling, it had to increase its yield to spur demand and liquidity. The adjustment sent shockwaves through financial markets.

In Europe, France is home to the largest bond market at $4.4 trillion in total debt, surpassing the United Kingdom by roughly $150 billion.

Banks: A Major Buyer in Bond Markets

Like central banks around the world, commercial banks are key players in bond markets.

In fact, commercial banks are among the top three buyers of U.S. government debt. This is because commercial banks will reinvest client deposits into interest-bearing securities. These often include U.S. Treasuries, which are highly liquid and one of the safest assets globally.

As we can see in the chart below, the banking sector often surpasses an economy’s total GDP.

Banking Sector

As interest rates have risen sharply since 2022, the price of bonds has been pushed down, given their inverse relationship. This has raised questions about what type of bonds banks hold.

In the U.S., commercial banks hold $4.2 trillion in Treasury bonds and other government securities. For large U.S. banks, these holdings account for almost 24% of assets on average. They make up an average 15% of assets for small banks in 2023. Since mid-2022, small banks have reduced their bond holdings due to interest rate increases.

As higher rates reverberate across the banking system and wider economy, it may expose further strains on global bond markets which have expanded rapidly in an era of dovish monetary policy and ultra-low interest rates.

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