The US dollar has made some tentative moves towards a slight recovery in recent months after a long slide downwards that seemed to puzzle many. In the short-term, the direction of travel seems to be up, but some commentators are expecting a long-term decline in the greenback’s value.
The dollar reacted positively to Donald Trump’s election, gaining 6% on a trade-weighted basis on anticipation of an economic boost thanks to potential tax cuts and infrastructure spending. But since then, it’s been on a downward spiral.
The dollar index, which measures the value of greenback against a basket of six developed market currencies, peaked just before Christmas 2016 at around 103. By February 2018, it had bottomed out 13.5% lower at around 89.
Trade war rhetoric was unhelpful, but there have been myriad factors that should have been positive for the dollar. Yield spreads have moved in favour of the dollar and tax reforms have been passed by Congress.
This shows, as Dan Kemp, chief investment officer at Morningstar Investment Management, notes, that many of the transactions that determine the price of currencies are not investment related. This means that currencies can deviate far from their fair value over long periods of time.
“Forecasting short-term currency movements is a fruitless exercise that is unlikely to benefit investors and may expose them to considerable additional risk”, explains Kemp.
Currently, as a pound sterling investor, Kemp thinks the dollar “appears expensive”, so his team is hedging their US dollar exposure gained through assets like US treasury bonds and US equities.
Dollar Could Plateau
Paul Jackson, head of multi-asset research at Invesco, agrees and says he finds it hard to have a strong view on the dollar and thinks in the medium to long term, it will be close to its current level. However, that doesn’t seem to be the popular view.
At the start of this year, Tom Becket, chief investment officer at wealth manager Psigma, explained the reasons behind his theory that the dollar is on a long-term decline. That view hasn’t changed, but he cautions investors to be “open-minded and flexible” while recognising that the long-term trend “is almost certainly downwards”.
“This year, there are a number of things going on which could be supportive at times of the dollar despite the fact that the general over-riding pressures are for the dollar to weaken,” says Becket.
Becket reckons the US’s omnipotence over the global trading system will weaken in future years. This is mainly due to other nations, particularly China, becoming more important. After years of reliance on the US dollar, China looks certain to begin to increasingly trade globally in renminbi in the years to come.
Another factor is the “extraordinary fiscal policies” the Trump administration is likely to implement, which include tax cuts and increased Government spending. “This will see the US fiscal deficit widen dramatically and a lot more issuance of US Treasuries.”
In combination, this will lead people to become concerned about the US dollar, which he predicts “will increasingly look like an emerging market currency”. “Yields going up at the same time as the currency weakening seems to be a likely trade for the US dollar in the next 10 years,” Becket continues.
How to Play Dollar Weakness
Emerging market currencies are likely to be the biggest winners of long-term dollar weakness, says Becket. Pictet Asset Management also likes emerging market debt in local currency terms, as it agrees that, over the next five years, the dollar will weaken, though not dramatically.
“We expect emerging market currencies on average to appreciate by 1.3% against the dollar,” says Supriya Menon, senior multi-asset strategist at Pictet. “It also benefits emerging market equities because they tend to outperform in periods here the dollar is weaker.”
Pictet’s forecasts for the next five years show non-developed market equities as the best performers, with emerging market local currency debt will lead fixed income returns.
Elsewhere, both gold and commodities will benefit. Becket says gold is “the best anti-dollar play”, though commodities are “perhaps more interesting” due to their appalling performance in recent years. To add to the latter point, he thinks some commodities could fall into supply deficit, which could also be positive.
Becket thinks more direct exposure to commodities rather than specifically buying companies at the moment. However, he recommends looking towards gold miners due to their attractive valuations relative to the gold price.
“Those are the sorts of investments I think you should have in your portfolio when you expect the dollar to start to weaken once again,” says Becket.
Kemp cautions investors about jumping to easy conclusions such as dollar earners will suffer from a fall in the dollar. “In reality, asset prices are driven by a number of factors and currency may have a relatively small impact on the price on an asset in the currency in question,” he explains.
