How Currency Strength Affects Global Returns

A US investor's return on a foreign asset is the asset's return in its own currency combined with the change in that currency's value against the dollar. When the foreign currency weakens, it takes away from the dollar return; when it strengthens, it adds. A hedged fund removes most of this exchange-rate effect and replaces it with a cost or gain set largely by interest rates.

Key takeaways

• The dollar return is (1 + local return) x (1 + currency change) - 1, a product rather than a sum, so the two effects compound on each other.
• An 8% local gain with a 6% fall in the foreign currency leaves a dollar return of 1.52%, not 2%.
• The Federal Reserve's broad dollar index rose 10.99% from January 3 to September 28, 2022, and fell 7.37% across calendar 2025.
• Hedging replaces currency swings with the interest-rate gap between the two currencies: it adds to the local return when US short-term rates are above the foreign currency's rates and subtracts when they are below.

The formula behind a dollar return

The SEC's investor guide to international investing lists currency exchange rates as a risk in their own right. When the exchange rate between a foreign currency and the dollar changes, it can increase or reduce the investment return. Foreign companies trade and pay dividends in their local currency, so dividends and sale proceeds must be converted into dollars.

The conversion can be written as one line.

Return in USD = (1 + local return) x (1 + FX change) - 1

local return = the asset's change in its own currency (price plus income)
FX change    = the change in the dollar value of one unit of the foreign currency
               (positive when the foreign currency strengthens against the dollar)

Adding the two numbers is only an approximation. The exact answer includes the cross term, local return times currency change, which is small when both moves are small and larger when they are not.

What "currency strength" means here

A stronger foreign currency means one unit buys more dollars. A stronger dollar is the same event seen from the other side: each foreign unit buys fewer dollars, so the FX change is negative for a US holder. Mixing up the two directions is an easy mistake, so the sign of the FX change in the formula is always defined from the foreign currency's side.

A worked example, with a grid

Illustrative example. A US investor holds a euro-denominated stock fund. Over one year the fund rises 8% in euros and the euro falls 6% against the dollar. The dollar return is 1.08 x 0.94 - 1 = 1.52%, before fees and taxes. Adding the two figures would give 2%, which overstates the result by 0.48 percentage points.

The same formula produces every cell of the grid below. Each figure is computed with the formula above and rounded to two decimals.

The last row shows why the simple sum misleads: a 10% gain and a 10% currency loss leave a 1% loss in dollars, because the currency loss applies to the larger, already-gained amount. The row before it shows the reverse case, where a falling local market is more than offset by a rising currency and the dollar return is slightly positive.

Returns over several years multiply

The formula applies period by period. Suppose an asset earns 5% locally each year while the foreign currency falls 3% each year. The dollar return is 1.05 x 0.97 - 1 = 1.85% per year, and over two years (1.0185 squared) - 1 = 3.73%. The local return alone would have compounded to 10.25% over the same two years, and the currency alone to -5.91%.

What the Fed dollar index showed

The Federal Reserve Board publishes a Nominal Broad U.S. Dollar Index (FRED series DTWEXBGS, index January 2006 = 100, daily). It measures the dollar against a basket of foreign currencies weighted by trade. In the Board's weights table, dated February 2, 2026, the euro area carries 21.007 of the 100 points, Mexico 14.801, Canada 12.769, China 10.891, the United Kingdom 5.246 and Japan 5.182. The index is therefore not the same as the euro-dollar rate, and a fund's own currency mix may differ from it.

Values are from FRED as of the series update of October 13, 2026; its highest daily reading since the series starts in January 2006 was 130.0413, on January 13, 2025. A rising index means a stronger dollar. A 10.99% rise in the index means the trade-weighted basket lost about 9.90% of its dollar value (115.4101 / 128.0884 - 1). That is roughly the FX change for an unhedged US holder whose currency mix matched the index weights; a portfolio spread differently across currencies would have seen a different figure. Over calendar 2025 the opposite happened: the basket gained about 7.96% (129.2775 / 119.7456 - 1) in dollar terms.

Illustrative example. Apply those basket moves to a foreign holding that earns 10% locally. In a 2022-style dollar rally the dollar return is 1.10 x 0.901 - 1 = about -0.9%, and a holding that fell 10% locally would be down about 18.9% in dollars. In a 2025-style dollar decline, the 10% local gain becomes about 18.8% in dollars. The currency leg here is larger than the asset's own move, which is why fund reports show local and dollar figures separately. Index moves are not forecasts, and a basket average will not match any single fund.

What hedging changes

A currency-hedged fund sells foreign currency forward, which is a contract to exchange at a fixed rate on a future date, to cancel most of the exchange-rate move. One published example is the MSCI EAFE 100% Hedged to USD Index, which hedges to the dollar by selling each foreign currency forward at the one-month forward rate. MSCI's hedged index methodology (August 2021) says this monthly approach replicates the hedging process in place in many actual portfolios. A given fund's hedge ratio and reset frequency can still differ, and the prospectus states them.

Two limits apply. In the MSCI method the amount hedged is kept constant over the whole month, and the index's performance within the month remains unhedged. Gains made after the reset therefore stay exposed to the currency until the next one. If the hedge in the earlier example were never reset during the year, the 8 euros of gain on each 100 hedged would face the full 6% fall, costing 0.48% of the starting value (0.08 x 0.06). With monthly resets, only the gain earned within each month is exposed, and only for the rest of that month. The hedge also does not touch the asset's own local return: a stock that falls 10% locally still falls about 10% in a hedged share class, before the effect of hedge costs described next.

What hedging costs or earns

A forward contract is priced off the interest-rate gap between the two currencies. Under covered interest parity, the forward premium or discount reflects that gap, as the BIS describes in its work on deviations from covered interest parity. A US investor who sells a foreign currency forward therefore earns roughly the difference between US and foreign short-term rates, whichever direction it points. The same BIS paper finds that heavy demand to hedge dollars can push the actual cost away from the pure rate gap, so the figure below is a benchmark, not a quote.

Hedged USD return ~ (1 + local return) x (1 + USD short rate) / (1 + foreign short rate) - 1

USD short rate     = US short-term interest rate over the hedge period
foreign short rate = short-term rate in the foreign currency, same period

Illustrative example with round rates. Take the same 8% local return, so the unhedged result with a 6% currency fall was 1.52%. If US short-term rates are 4% and euro rates 2%, the hedged return is 1.08 x 1.04 / 1.02 - 1 = 10.12%: the local 8% plus a 2.12-point pickup from the rate gap. If the rates are reversed, with US rates at 2% and euro rates at 4%, the hedged return is 1.08 x 1.02 / 1.04 - 1 = 5.92%, a 2.08-point cost. With the same 8% local return, the three outcomes are 10.12% (hedged, US rates higher), 5.92% (hedged, US rates lower) and 1.52% (unhedged, with the 6% currency fall). Had the euro risen 6% instead, the unhedged result would have been 14.48%, above both hedged figures.

Real fund results also reflect other items: any separate fees or trading costs of the hedged share class, the gap between forward and spot prices, and the remaining exposure on gains. The pure rate-gap figure explains the main driver; it is not a prediction that hedging will help or hurt in any year.

Frequently asked questions

Do dividends and interest payments carry currency risk too?

Yes. Foreign companies pay dividends in their local currency, and the SEC notes that the cash must be converted into dollars. The rate on the conversion date sets the dollar amount, so an unhedged holder receives more or fewer dollars for the same local dividend.

Does a strong dollar always hurt foreign holdings?

It lowers the dollar value of unhedged foreign assets relative to their local value, but the asset's own return still counts. In the grid, a local gain of 8% leaves a dollar gain of 1.52% against a 6% currency fall, and a 10% local gain stays positive in dollars unless the currency falls by more than about 9.1% (1 / 1.10 - 1). The net result depends on both legs.

Is the dollar index the same as the euro-dollar rate?

No. The Fed's broad index is trade-weighted across many economies, and the euro area is only the largest of them at 21.007 of 100 in the February 2026 weights. A fund that holds only European stocks follows the euro far more closely than the index does.

Can hedging add to a return?

It can. Because the forward price reflects the rate gap, a US investor who hedges a foreign currency whose short-term rates are below US rates earns roughly that gap, as in the 10.12% example above. The gain can reverse when the rate gap flips, and the BIS finds that dollar-hedging demand can change the actual cost.

Do hedged and unhedged versions of a fund hold the same assets?

The design intends the same equity exposure plus a currency overlay. The MSCI EAFE 100% Hedged to USD Index, for example, hedges the currency exposure of its parent, the MSCI EAFE Index, so the stocks are the same and the forward contracts are added. A fund's prospectus shows how its own hedged version is built and what it charges, and expenses can differ between versions. A fair comparison uses the same period and shows costs separately.

Checking a fund's currency effect

1. Find the fund's return in its local or fund currency and in dollars for the same dates, and confirm the start and end dates match.
2. Compute the implied currency effect: (1 + dollar return) / (1 + local return) - 1. For a 1.52% dollar return and an 8% local return this gives -6%.
3. Check whether the share class is hedged, the hedge ratio, and how often the hedge resets, all in the prospectus.
4. Compare a hedged and an unhedged class of the same fund over the same period, with expense ratios noted separately.
5. Look up US and foreign short-term rates for the period to see how much of any hedged-versus-unhedged gap is the rate gap.
6. Use the investment growth calculator to see how a yearly dollar return compounds over several years.

Sources

• SEC, brochure on international investing: currency exchange rate risk and dividends paid in local currency
• Board of Governors of the Federal Reserve System, Nominal Broad U.S. Dollar Index (DTWEXBGS), via FRED
• Federal Reserve Board, H.10 release: currency weights for the dollar indexes (February 2, 2026)
• MSCI, EAFE 100% Hedged to USD Index: one-month forward hedging method
• MSCI, Hedged Indexes Methodology (August 2021): amount hedged kept constant over the month
• Bank for International Settlements, Working Paper 590: the failure of covered interest parity