7th May 2015
One tangent of monetary policy that the US Federal Reserve will have on its radar screen in the coming months is the trajectory of the US dollar writes Jason Vaillancourt co-manager of Canada Life Investments’ CF Canlife Total Return fund…
The greenback has appreciated in value against nearly every currency since the middle of 2014, making particularly strong gains of about 20% versus the euro and yen. Yet US GDP growth and nominal interest rates compare favourably with those of other countries.
Currency strength has several effects. It holds inflation in check but also constrains growth by stimulating imports while making exports less competitive. In many ways, it has similar effects as tightening monetary policy, allowing the Fed to move slower on rates. Of more immediate concern to investors is that the dollar can also undermine the earnings of large US multinationals. Companies in the information technology, energy and materials sectors generate more than half of their revenues from operations outside the US. These revenues are translating into fewer dollars in corporate cash flow these days.
While we recognise the theoretical risk to earnings, our empirical research shows that a strong dollar has not consistently undercut earnings in the past. We believe it may take more than a mighty dollar to make US equities less attractive than other opportunities. Within active currency, our US dollar strategy favours a modest overweight position. The pillars for US dollar strength are based upon relative growth outperformance, the subsequent implications for the attractiveness of US assets and relative monetary policy.
Turning to our dollar-euro strategy, we have moved towards a more neutral position. Growth in the eurozone continues to improve and shows signs of stabilising at modest levels, and inflation readings have recovered somewhat, although there remains some scepticism about the ECB’s credibility on inflation targets. We favour a slightly longer position against sterling. In the UK, growth levels remain solid while inflation and inflation expectations have come down.