Dynamics for the US dollar are positive in the short term, but don’t expect it to last, argues Kames’ Gareth Gettinby
We expect the US dollar to continue its recent recovery into year-end, as it is boosted by improving US economic data, a more hawkish Federal Reserve and an increasing likelihood that US fiscal policy turns supportive. These dynamics are positive in the short term as interest rate differentials are pushed higher.
However, we believe this is only a temporary respite for the US dollar and we expect fresh weakness in 2018.
There are a number of reasons for this.
- Whilst we fully expect the Fed to increase rates in December and again in 2018, this is not necessarily beneficial for the dollar; positive short-term interest rate spreads against the Eurozone have thus far failed to prevent the currency falling this year against the euro.
- Although the Fed has begun policy normalisation, other central banks are getting closer to tightening policy, making the dollar less attractive – as policy normalisation should strengthen their currencies.
- Improving global growth trends mean less compelling US growth differentials against other countries, and therefore less demand for assets in the US – reducing support for the currency over the medium term.
- The level of the twin deficits (the sum of fiscal and current account) as a percentage of GDP suggests the US dollar should trend lower. Whilst increased trade may improve the current account deficit, the fiscal balance will decline rapidly if Trump’s tax changes come to fruition. To fund these deficits, the US dollar may need to weaken.
- Speculators are currently neutrally positioned; there remains considerable scope for sentiment to change against the currency.
So what does this mean for markets? US-based firms who export a large amount of their products should benefit from a weaker dollar as their exports become cheaper for international buyers. Of course, importers will feel the opposite effect as their cash suddenly purchases less. This should support large multinationals over domestically focused importers, supporting their corporate bond spreads and equity valuations.
Outside of corporates, the areas most exposed to changes in the US dollar are commodities and emerging markets. Both of these tend to move inversely to the currency, and as such both should benefit from a weaker dollar. Those issuing dollar-denominated debt, particularly in emerging markets, may breathe a sigh of relief as their payments become less onerous as their local currency appreciates against the dollar.
How are we positioned?
A declining US dollar, combined with improving global growth, will likely create many opportunities for us to exploit. However, as the macroeconomic picture continues to evolve, a supportive backdrop for risk combined with valuations that appear high is a strong argument for ensuring you know what you own in your portfolio.
Conscious of this, we always ensure we are paid for the risks we take. Risk assets such as corporate bonds and equities will tend to perform well against a backdrop of improving global growth and a normalisation of monetary policy. As such, our multi-asset portfolios hold healthy allocations to equities, emerging market debt and bank credit. We also have a meaningful allocation to alternatives such as infrastructure, REITs and renewables which provide excellent diversification properties.
Diversification is important. Our broad-based approach to portfolio construction builds a portfolio that is not overly exposed to a single factor such as the US dollar, while our flexibility also allows us to take advantage of price dislocations inspired by currency moves.
Ultimately, for our multi-asset funds we aren’t overly worried about the direction of the dollar. Our response remains to invest in a diverse range of global assets.
Gareth Gettinby is multi-asset investment manager at Kames Capital