17th July 2013
The dollar had been on a tear, but has sold off in recent days as global currency traders have started to fret about the next policy action (or not) from the Federal Reserve. Some experts have pointed out that a stronger dollar does not necessarily go hand in hand with monetary tightening. What is the outlook for the dollar? And what does it mean for investors asks Cherry Reynard.
In a recent video interview with the FT.com, David Bloom, head of forex research at HSBC, points out that higher interest rates have not always been positive for the dollar: “If the Fed is seen to be chasing inflation, it tends to be that the dollar falls. In 1994 the Fed tightened rates dramatically and yet the dollar went down because people thought they were behind the curve. When people think they are ahead of the curve, moving for economic rather than inflation reasons, it tends to be pretty positive for the dollar.”
Bloom is a long-term bear on the dollar, but believes that it is likely to rise in the short term given the stronger growth in the US economy, the lack of any significant inflation risk and the difference in monetary policy between the US and other developed countries.
Gary Dugan, Chief Investment Officer, Asia & Middle East at Coutts is also optimistic: “Our expectation that the Fed will err on the side of caution was reinforced by Bernanke’s latest comments. But the US recovery is on a firmer footing than in the UK or eurozone economies, and we forecast moderate dollar gains against the euro and sterling over the next 12 months.”
But there are still plenty of dollar bears around. On CNBC, Clifford Bennett, chief economist at Sydney based financial services firm the White Crane Group, believes the dollar is due a correction of 15% over the next 18 months as the “dollar bubble bursts.”
He adds: “This week saw the start of a potential major shift lower in the value of the U.S. dollar…The moment that speculative buying begins to retreat, the U.S. dollar will, and most likely has already, begin a sustained period of decline.”
Didier Saint-Georges, member of the investment committee at Carmignac Gestion warns that the currencies of all countries with significant current account deficits are fragile. The current-account deficit in the U.S. widened by 3.7% in the first quarter, on the back of a jump in imports to $106.1 billion.
So there is currently little consensus on the outlook for the dollar.
But would a stronger dollar be good for equities? Felix Wintle, manager of the Neptune US Opportunities fund, is a significant dollar bull. He highlights the connection with commodity prices, saying that a climate of a weak dollar and strong commodities tends to be negative for equities, while a strong dollar, weak commodities environment – such as the one we are in at the moment – is usually strong for equities.
Bruce Stout, manager of the Murray International investment trust, is not so sure. He says: “One of the other firmly entrenched trends over the last 18 months has been the rise in the US dollar. And in many ways that’s not surprising because the United States is actually one of the few places in the world today where there’s a positive real interest rate. Because the inflation rate in America is running at 1.1% on the CPI and investors receive 2% on ten year treasuries, so there is a positive real interest rate from a ten year bond, which can’t be said for anywhere else in the world at the moment. That’s been obviously attracting some money into the dollar and the relentless rise in the US dollar is going to be negative for repatriated earnings on equities at some point and it is something that we are very concerned about for our US holdings.”
This piece on Seeking Alpha points out that some companies are already being affected by the stronger currency. “We know that a strong currency hurts exporters and benefits importers ,but the foreign earnings of multinational corporations will also be negatively affected by a strong currency. In fact, many U.S. companies blamed the strength of the dollar for weaker earnings in the first quarter and the impact was seen in companies across different industries.
“Three high profile examples are 3M, Phillip Morris and Avon. The cigarette maker took a 7-cent hit on currency fluctuations, which actually turned its 1 cent profit into losses in Q1. Avon, which generates over 85% of its total revenue from outside of the U.S., saw currency fluctuations shave 4% off of earnings. If the dollar continues to rise due to diverging monetary policy directions, we can expect more disappointments in Q2 earnings.”
For UK investors, a stronger dollar will be good for those who already hold US assets, but bad for those who want to buy in. With the US stock market already trading at historically high valuations, those buying in as the dollar rises risk a double hit from any devaluation in the stock market and the currency. For those worried about the currency risk, there are some fund managers that hedge their exposure.
It is tempting to ignore the impact of currency, on the basis that it all works out over time, but it can have a significant effect on shorter-term performance. While sterling and the Euro have remained relatively stable, the dollar is currently seeing a lot of volatility. Investors need to ensure they understand the risks they are taking.