The Market Crash Americans Aren't Seeing

Bearish sentiment has overtaken Wall Street, and just about the only good news that came from Friday's trading session was that the Dow Jones Industrial Average (^DJI 0.58%), S&P 500 (^GSPC 1.12%), and Nasdaq Composite (^IXIC 1.54%) bounced off their worst levels of the day to finish above their worst close of the year back in June. Even with the slight recovery, though, indexes were down 1.5% to 2%.

Data source: Yahoo! Finance.

As important as stock markets are, they're not the only financial market that investors should pay attention to. Indeed, the Federal Reserve's aggressive interest rate increases have also made big ripples in the foreign exchange markets, and the moves there have shown the impact that higher interest rates for U.S. assets have had on currencies of other nations around the world. That has good and bad news for U.S. investors and consumers, depending on exactly what your portfolio and personal financial exposure to foreign markets happen to be.

Image source: Getty Images.

Historic moves in currencies

Not only have major foreign currencies lost considerable value against the U.S. dollar, but the speed of the declines has been nearly unprecedented. Consider some recent moves:

• The value of the euro fell 1.5% today alone, dropping below $0.97 and hitting levels not seen in roughly 20 years.
• The British pound saw even steeper declines, plunging 3.5% to $1.085. That was the biggest daily move since the initial volatility at the beginning of the COVID-19 pandemic in early 2020, and the exchange rate was the weakest the pound had been against the dollar since the mid-1980s.
• The Japanese yen has also been struggling of late, with the dollar recently fetching 146 yen, its highest since 1998. The move downward in recent months has been so severe that the Japanese central bank intervened in the foreign exchange market for the first time in 24 years to try at least to slow the pace of the drop.
• Other currencies are also unusually weak. The Canadian dollar dropped to 73.58 U.S. cents, while the Australian dollar hit 65.3 U.S. cents. The Swiss franc was down slightly to $1.02, with the dollar threatening to break parity there as well.

More broadly, the U.S. Dollar Index, which measures the strength of the greenback against a basket of other currencies, hit highs not seen in more than 20 years.

The explanation is fairly simple. With the Federal Reserve having raised interest rates, investors in U.S. dollar-denominated investments like bonds can get relatively high returns. Foreign investors therefore exchange their foreign currency to U.S. dollars in order to purchase those securities, boosting the greenback's value relative to foreign currencies.

What it means for U.S. stocks

A strong dollar is great news for U.S. companies that rely on importing materials and then primarily sell finished products to U.S. consumers. Better exchange rates reduce their import costs and bolster margins.

Unfortunately, the reverse is true for U.S. companies with extensive operations abroad. The revenue that a multinational generates from a country whose currency is weak translates into fewer U.S. dollars, weighing on sales growth and profitability. One extreme example is Philip Morris International (PM 2.22%), which relies pretty much entirely on non-U.S. sources for its international tobacco business. However, plenty of other consumer giants do considerable amounts of business abroad and could see pressure on their earnings from the strong dollar.

In the midst of significant stock market declines, it's easy to miss just how important the extreme volatility in foreign exchange markets could be. With Europe still under threat from Russia's invasion of Ukraine and supply chain issues plaguing global trade, any vulnerability in currency markets could lead to unexpected systemic disruptions if conditions don't improve soon.