More favorable valuations internationally, FIGURE II-14 however, are not a new story. Nevertheless, Dollar strength has held back international international has been unable to generate performance for U.S. investors this year any significant outperformance relative to the U.S. This is in large part because of the dollar’s MSCI MSCI MSCI MSCI MSCI UK Europe Japan EM USA strength, which has reduced an unhedged U.S.- Index Index Index Index Index based investor’s return on international equities % Local return this year. As of September 30, 2022, our capital Currency return markets model suggests that the U.S. dollar is n– r 13% above what the fundamental, long-term u t e drivers of currency value suggest. This leads us l r a t o to project a 1.2% annualized decline in the dollar T– relative to a basket of international currencies over the next decade. – Figure II-14 shows how a strong dollar has Notes: The chart breaks down the unhedged USD return from December amplified losses in international equities for 31, 2021, to September 30, 2022, into the local and exchange rate return unhedged U.S.-based investors. This effect has components. The indexes used are the MSCI UK Net Total Return Index, the MSCI Europe Net Total Return Index, the MSCI Japan Net Total Return Index, been particularly acute in developed markets the MSCI Emerging Market Net Total Return Index, and the MSCI USA Net where returns have held up much better in Total Return Index. The currency exchange rates are the EUR/USD, GBP/ USD, and JPY/USD cross-rates. The MSCI Emerging Markets currency return local currency terms because of less-stretched is derived using the local currency index, which accounts for exchange rate valuations. Currency returns are notoriously differences based on each country’s weight in the index. difficult to forecast over short investment Sources: Vanguard calculations, based on data from Bloomberg and Global Financial Data, as of September 30, 2022. horizons, and many factors can cause them to 14 deviate from their fundamentals. However, over a sufficiently long investment horizon, we expect global inflation and policy convergence to lead to exchange-rate normalization. 14 Because all currencies are relative pairs, it is possible that the headwinds the U.S. dollar faces will be even stronger for international currencies, which would cause the U.S. dollar to strengthen, all else equal. 52