Expect currency to play a smaller role in future returns

By Kevin DiCiurcio, Head of Vanguard Capital Markets Model Development

Markets and economy

U.S. dollar depreciation this year has driven international equity outperformance

For the past three years, the U.S. dollar stood tall – overvalued and seemingly defying its fundamental gravity. But in recent months, it’s come back down to a level that we assess to reflect long-term fair value compared with a basket of developed-market currencies.

 

The U.S. dollar has retreated to fair-value territory

^{Notes: The chart shows our fair-value estimate for the U.S. dollar against an equity market capitalisation-weighted basket of the euro, the Japanese yen, the British pound, the Canadian dollar, and the Australian dollar. The fair-value estimate is based on the part of exchange-rate movements that can be explained through differentials in relative economic strength, measured by productivity (GDP per capita at purchasing power parity) and long-term real rates.}

^{Sources: Vanguard calculations, based on data from Refinitiv and the International Monetary Fund, as of June 30, 2025.}

The downward shift has been a gift to globally diversified U.S. investors. As the dollar weakened – triggered in part by a global reconsideration of appetite for U.S. assets amid tariff upheaval – non-U.S. equity returns surged when translated back into U.S. dollars, giving portfolios a meaningful lift.

With U.S. equity valuations still stretched and non-U.S. markets offering more historically grounded return prospects, spreading risk across regions remains a cornerstone of a sound long-term strategy.

Non-U.S. returns also benefited from depressed valuations that reflected very pessimistic sentiment at the start of the year. This, along with the weakening U.S. dollar, led international equities in U.S. dollar terms to return 17.9% in the first six months of 2025. Non-U.S. equities returned 8.8% in local currency, while the dollar contributed the remaining approximately 9%. (U.S. equities, by comparison, returned 6% in the first half of 2025.)¹ Looking ahead, the degree to which corporate fundamentals abroad can rise to meet this renewed optimism will be key for further non-U.S. equity gains.

With the U.S. dollar now firmly back within our estimated fair-value range, we view the risks as more balanced than at any time during the last three years. Over the short term, an easing of trade tensions and greater certainty around U.S. policy may lead to U.S. dollar appreciation. Alternatively, a continued reconsideration of U.S. dollar-denominated assets among global investors could result in further declines. Longer term, however, we see higher U.S. productivity and persistently higher (but sustainable) U.S. interest rates as supportive of the current U.S. dollar valuation.

The shift reinforces the case for global diversification. With U.S. equity valuations still stretched and non-U.S. markets offering more historically grounded return prospects, spreading risk across regions remains a cornerstone of a sound long-term strategy.²

 

^{1 U.S. equities are represented by the MSCI USA Net Total Return Index, international equities in USD are represented by the MSCI ACWI ex USA Net Total Return USD Index, and international equities in local currency (which is not investable) are represented by the MSCI ACWI ex USA Net Total Return Local Index. All returns are based on data from Bloomberg as of June 30, 2025.}

^{2 Vanguard’s 10-year outlook assigns a 66% probability to international equities outperforming U.S. equities, driven by valuation and earnings growth differentials.}

^{Notes:
All investing is subject to risk, including the loss of the money you invest.
Investments in stocks issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.
Diversification does not guarantee you’ll make a profit or that you won’t lose money.}