Investment Committee: What next for volatile currencies?

Beth Brearley
Editor
Fund Strategy 

The past year has seen extreme volatility among the major currencies, a barometer for the global political uncertainty.

In December the dollar hit a 14-year high, with the dollar index recently reaching 103.82, its highest level since December 2002. On the flip side, a flash crash in sterling last October saw the pound plummet to a 31-year low. However, sterling weakness has provided a boost to overseas companies, with the FTSE reaching all-time highs.

In the UK, an element of certainty has been restored following Prime Minister Theresa May’s confirmation that the UK will leave the single market and the publication of a white paper on the proposals. Following her speech in mid-January, the pound rallied 1.74 per cent, albeit from a low level, with her main points having been priced in during the preceding days.

Across the pond, President Trump has been sworn in. While all eyes have been on his controversial national security measures, Trump has also been meeting with business leaders, reiterating his planned tax cuts and reduction in red tape for businesses. However, Trump-based optimism apparently faltered with the dollar falling to a seven-week low.

In Europe, this year sees key elections in The Netherlands, France and Germany, with all the uncertainty and potential disruption that entails. Currency is, of course, a zero sum game. With political global upheaval unlikely to abate any time soon, which currencies are going to be the winners and losers in 2017? And what will be the political, economic and investment implications?

John Husselbee
Head of multi-asset
Liontrust Asset Management

For a number of years policy makers around the world have sought a weaker currency policy to promote economic growth via exports and import inflation.

The challenge is that currency is a relative trade and not everybody can pursue this policy at the same time. More recently the foreign exchange markets have taken the brunt of uncertainty in political surprises. Last year the unexpected happened when two major European prime ministers were forced to resign post-referendum results and then Donald Trump defied the pollsters. This political uncertainty is forecast to continue into the medium term.

Sterling devaluation around UK referendum rhetoric has been savage, but looking ahead it seems unlikely it will drastically weaken. Indeed, we’ve already seen how Brexit negotiations have affected currencies. On the other hand, after the recent second step in the US interest rate tightening cycle the dollar could continue to strengthen. This would be positive for those holding US dollar assets but negative for emerging markets.

Tim Cockerill
Investment director
Rowan Dartington

Currency exposure made a big difference to returns in 2016 and while I expect currency to be important in 2017, I think it will have less impact than last year.

However, with politics primed for more off-the-cuff remarks, I’m anticipating elevated volatility, whether or not it’s followed through with actions, as comment is immediately reflected in currency markets.

Much of this, however, is short-term noise, and important economic data still finds itself reflected in currency values long term.

Sterling might be cheap if Brexit is less damaging than expected. The euro may be resilient if popular politics doesn’t jeopardise the wider project.

The yen looks cheap, but Japan has a number of challenges, not least sluggish GDP and its debt burden. As for the US dollar, currencies are a relative game, so the US dollar could be expensive.

After the ructions of 2016 currencies may be more settled this year. But if Trump engages in tariff setting, then countries like China can respond, with their own tariffs and through devaluation.

Peter Lowman
CIO
Investment Quorum

Clearly, returns in markets have been very rewarding, particularly for UK investors, with overweight positions in global equities, given the 18 per cent devaluation in sterling. Likewise, the US dollar rallied against a backdrop of potential rate hikes.

With US President Donald Trump sworn in, Prime Minister Theresa May adamant about invoking Article 50, and the ECB proposing to reduce their QE programme, currencies will see significant ramifications.

Consequently a strengthening dollar, against a backdrop of uncertain Trump policies; further sterling weakness as the UK begins its process of leaving the European Union and a weaker euro as political events unfold in the European elections will create further volatility.

And as for the yen and yuan, domestic events, and the US dollar, will affect their directional paths, while exporters in countries with weakening currencies will continue to benefit from corporate earnings upgrades. However, the negative effect from import costs will create further inflationary pressures.

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Mike Deverell
Investment manager
Equilibrium Asset Mgmt

Currency movements are currently playing a big role in investment returns.

For example, investors in UK equities have seen some excellent returns recently. This has largely been driven by the falling pound as many UK companies actually make most of their profits overseas. This means profits have risen in sterling terms. As a result, even a UK investor who only invests in UK stocks will be exposed to currency risk.

Avoiding currency risk is therefore nigh on impossible. Unfortunately, so is forecasting which direction currencies will go. Take the sterling/dollar exchange rate. Which direction this moves depends on factors such as how Brexit negotiations go, what policies Trump announces, whether he can get them through Congress, and whether interest rates go up faster or slower than expected.

Our approach to currency risk is to accept it but manage through diversification. If we invest overseas we do not hedge, but because we invest globally we are exposed to many different currencies around the world.

James Calder
Head of research
City Asset Management

Currency, for some equity markets, has become a major driver of performance and therefore needs to be assessed when making allocation decisions.

Historically, currency was considered a variable but one where it would “come out in the wash”, with most investors happy to be unhedged. This changed after the global financial crisis and as central banks embarked on a policy of using currency as a monetary tool; one only has to look at the number of ex-UK funds that now have a sterling hedged share classes available.

The weakening of sterling post the Brexit referendum has favoured those who took a negative view on our home currency and chose not to hedge. One only has to look at the calendar year returns of the S&P500 in local versus sterling terms.

Our view is that while the US dollar has rallied, it will continue to strengthen –  albeit with the odd pullback – through 2017, with a rising rate environment in the US and an accommodative stance from the ECB and BoE being the drivers.

John Redwood
Chief global strategist,
Charles Stanley

Currency movements can play a big part in investment returns. Last year UK investors in overseas shares made double figure gains in the foreign currencies in the main markets. This year the world economy and shares will depend in part on how strong the US dollar becomes.

Although the US dollar has been strong for many months we would expect that to continue further.

US interest rates are higher than UK, Japanese and Euro area rates, and likely to go higher. This will attract footloose money.

US president Donald Trump is determined to get US companies to repatriate large offshore profits, creating a potential dollar shortage elsewhere.
If dollar rises are modest in scale it should be bullish for the world economy.
If the dollar becomes too strong it will adversely affect emerging economies and tighten money and credit too much.

We think we have seen the worst of sterling’s performance against other currencies, now the bank is saying rates could go up in the UK.

Russ Mould
Investment director,
AJ Bell

The key currency for markets in 2017 is the US dollar. A strong dollar is inherently deflationary for the rest of the world, or at least it serves to tighten economic conditions, for two main reasons.

First, commodities are all priced in dollars, barring cocoa, which uses sterling so a rising greenback makes raw materials more expensive – and higher oil and fuel costs hit consumers and many firms straight in the pocket.

Second, global borrowing has ballooned even since the great financial crisis and much of this is priced in dollars, so a rising US currency makes it harder for those international borrowers to service their debts, offsetting the benefits to an economy of a lower domestic currency, such as improved competitiveness and exports.

The dollar, as benchmarked by the DXY trade-weighted basket (known as Dixie) trades at around 100 right now. Yet it reached nearly 120 in the early 2000s and 160 in the mid-1980s.

If Trump’s reforms are implemented – and work – and the Federal Reserve follows through with its planned three rate hikes this year, it seems possible the buck will go higher, even allowing for how short-term positioning suggests the dollar is overbought and a consensus trade. Not least as Europe, the UK and Japan are still running QE schemes and showing no inclination to tighten monetary policy.

A truly successful Trump trade could ironically short-circuit itself if the dollar and US rates start to move sharply higher, to the detriment of US and global economic growth.