A stronger greenback will ultimately hinder the U.S. stock market's performance as domestic exporters receive less cash for their products abroad, according to Capital Economics.
The U.S. dollar hit multi-year highs against several currencies this week, including a seven-year high against the Japanese yen, after Republicans gained control over both chambers of Congress for the first time since 2006, raising hopes of more pro-business policies.
At the same time, U.S. stocks have been powering higher. The S&P 500 and Dow Jones hit record highs on Thursday, and are up 9.48 percent and 5.48 percent year to date, respectively.
"Although the U.S. stock market has rebounded in recent weeks, its upside could by limited if, as we forecast, the rally in the dollar continues," Capital Economics analysts said.
A stronger greenback means U.S. exporters will be faced with a conundrum: cut profit margins by keeping the foreign currency price of its exports unchanged or risk losing market share by hiking prices abroad. Either way, the dollar's rise will prove a hindrance, Capital Economics said.
Companies selling goods at home, that compete with imports from foreign countries, will also lose out, Capital Economics said. Foreign companies can cut the dollar price of their exports without hurting the value of profits in their home currency, putting them at an advantage and increasing their market share.
"Finally, fluctuations in the dollar's value also affect the earnings of U.S. companies' foreign affiliates, which are very sizeable… As the dollar rises, those overseas earnings are worth less in U.S. currency," the analysts added.