It’s wildly fashionable among investment circles to bash the US Dollar’s prospects. Profligate US Government spending, our Federal Reserve’s easy money policies, and the soaring gold price are heralded as proof of the Dollar’s weak outlook. Investors are concerned that a weak Dollar will result in inflation, more expensive imports, capital leaving our shores and depreciation of Dollar denominated assets. While there are few things all investors can agree upon, many see the Dollar headed for ruin.
Bottom Line
Many investors are structuring their portfolios with an underlying assumption that the Dollar can only fall. They are flocking to commodities, foreign currencies, gold, overseas stocks and bonds and similar amid a widely held view that a continued collapse of the US Dollar will make them profitable. Similarly, they shun domestic stocks, particularly those with little or no foreign exposure, US Treasury debt, and Dollar oriented instruments because they’re viewed as providing little protection against Dollar weakness.
You make a mistake if you make too big a bet on Dollar weakness. Currency movements are notoriously difficult to predict. Even if you guess right, you need to be wary if you’re forecasting something that’s already reflected in asset prices, so that there’s little profit even if you’re correct, and you court big losses if you’re wrong.
Take a long term view, focusing more on long term fundamentals of economic growth as opposed to short term currency plays. Below are five reasons why you should avoid being too bearish on the Dollar in 2010.
1. Forecasting Currency Movements is Extremely Difficult
If you think forecasting the stock market is tricky, try forecasting the currency markets. Complex economic themes come into play, including inflation rates, nations’ economic growth rates, interest rates, money supply growth, and changes in nations’ budgets. Heed the old Wall Street saw: “There are only two economists in the world who understand currency movements, and they disagree.”
Even if you can understand the factors underpinning one currency, you need to understand the factors underpinning other currencies, commodities, and other metrics by which you can measure a currency’s movements. These are dynamic, as ongoing changes in a currency may well generate reactions by governments and the market to offset and nullify those changes.
Like your opinion on the stock market or a single stock, there’s always another side to the story. After all, if you are going to sell your Dollars to exploit your belief in future Dollar weakness, you’ll need to find one holding the opposite view who will buy your Dollars and sell you your new investments. It’ll be costly to assume that those taking the opposite side of your bet are always wrong.
2. Interest Rates May Rise
One of the key reasons that the Dollar has been weak is our very low interest rates. To fight the worst economic crisis since the 1930s, the Fed has injected the most liquidity ever into the economy in its 96 year history. The result has been a Federal Funds rate between 0% and .25%. Much of the Dollar weakness is due to the “carry trade,” borrowing Dollars at extremely low rates and selling them for currencies yielding more; for example, Australia’s benchmark lending rate is 3.75%.
At some point the Federal Reserve may increase the Federal Funds rate as our economy rebounds. That increase may be sudden and substantial. At that point those engaging in the carry trade may worry that when they need to rebuy the Dollar to repay their cheap loans, the US Dollar may have appreciated, plus of course their loan’s interest rate may have risen. The inevitable unwind of the carry trade will boost the Dollar substantially.
Unless you believe that US interest rates will not rise, you must brace for higher rates driving the Dollar up.
3. Investors May Embrace the Dollar Should the Global Economy Hiccup
During the financial crisis precipitated by Lehman’s collapse, the Dollar soared in value as investors focused more on return of principal than return on principal. Investors rushed to trade out of risky assets, like commodities, overseas borrowers, even foreign currencies, to repay their Dollar loans. In the same way that the worries engendered by 9/11 brought assets to the US, if we should have another financial crisis investors may once again line up to transfer their assets to America, driving up the Dollar in the process.
The recent debt moratorium announced by Dubai World underscores the risks still lurking in the global economy. In the wake of that announcement the Dollar jumped as investor grew fearful of overseas risks.
Unless you believe that the global economy has completely recovered from the “Great Recession,” you need to brace yourself for a rush to the Dollar following the next shoe to drop in this global financial crisis.
4. The US Economy May Strengthen
Even if the global economy doesn’t hiccup, if the US economy gains strength, our interest rates will tend to rise, investor interest in the US will increase, and concerns over the Federal budget deficit will decrease. All of this will make the Dollar a more desirable currency, boosting its price.
A number of metrics suggest the United States is emerging from recession. For 2009’s third quarter we reported our first growth in our Gross Domestic Product after four straight negative quarters. The housing and auto industries are recovering. November’s jobs report showed a net loss of just 11,000 jobs, the smallest since the start of the recession and the biggest one month decline in more than three years.
This will boost interest rates by increasing the demand for funds as borrowers grow more optimistic about the future. Overseas investors will buy Dollars to take advantage of our improved outlook. Tax receipts will increase, placing our Dollar less at risk from our budget deficit.
So, before you effectively short the Dollar when investing consider the implications of a strengthening US economy.
5. The Commodity Bubble May Lose Air
Commodities have been on a tear, perhaps even entering into a bubble phase, despite a very weak global economy. Because commodity prices are cyclical and their price movements seem not to be supported by fundamental demand, a reversal in their prices may be at a hand. Commodities and the value of the Dollar are generally inversely correlated; a top in commodity prices may signal a halt to the Dollar’s decline.
Gold has soared 387% over the last 10 years, and is up 32% this year alone. Copper has more than doubled in 2009. Oil is up nearly 8 fold since 1999.
Investors should watch commodities closely in 2010. Their retreat may coincide with the Dollar’s rise.
Investment Implications
Dollar denominated assets will perform better than non Dollar denominated assets should the Dollar strengthen. This would raise the risks for overseas stocks and bonds.
Among Dollar denominated assets, those with little overseas exposure could trump so called US multinationals, such as McDonalds. Economic sectors with less overseas exposure would include small cap stocks, utilities, banks, and retailers.
Sectors of the economy reliant on rising commodity prices may struggle relative to sectors somewhat insulated. Natural resource companies, including energy and mining concerns, may suffer from lower than anticipated revenue streams. On the other hand, the health and technology sectors may see no ill effects if the Dollar strengthens and commodities cheapen. Transportation companies, like the rails, autos, and airlines would undoubtedly benefit from the Dollar purchasing more units of energy.
David G. Dietze, JD, CFA, CFP™
President and Chief Investment Strategist
Point View Financial Services, Inc.
Summit, NJ
e-mail: [email protected]
Bottom Line
Many investors are structuring their portfolios with an underlying assumption that the Dollar can only fall. They are flocking to commodities, foreign currencies, gold, overseas stocks and bonds and similar amid a widely held view that a continued collapse of the US Dollar will make them profitable. Similarly, they shun domestic stocks, particularly those with little or no foreign exposure, US Treasury debt, and Dollar oriented instruments because they’re viewed as providing little protection against Dollar weakness.
You make a mistake if you make too big a bet on Dollar weakness. Currency movements are notoriously difficult to predict. Even if you guess right, you need to be wary if you’re forecasting something that’s already reflected in asset prices, so that there’s little profit even if you’re correct, and you court big losses if you’re wrong.
Take a long term view, focusing more on long term fundamentals of economic growth as opposed to short term currency plays. Below are five reasons why you should avoid being too bearish on the Dollar in 2010.
1. Forecasting Currency Movements is Extremely Difficult
If you think forecasting the stock market is tricky, try forecasting the currency markets. Complex economic themes come into play, including inflation rates, nations’ economic growth rates, interest rates, money supply growth, and changes in nations’ budgets. Heed the old Wall Street saw: “There are only two economists in the world who understand currency movements, and they disagree.”
Even if you can understand the factors underpinning one currency, you need to understand the factors underpinning other currencies, commodities, and other metrics by which you can measure a currency’s movements. These are dynamic, as ongoing changes in a currency may well generate reactions by governments and the market to offset and nullify those changes.
Like your opinion on the stock market or a single stock, there’s always another side to the story. After all, if you are going to sell your Dollars to exploit your belief in future Dollar weakness, you’ll need to find one holding the opposite view who will buy your Dollars and sell you your new investments. It’ll be costly to assume that those taking the opposite side of your bet are always wrong.
2. Interest Rates May Rise
One of the key reasons that the Dollar has been weak is our very low interest rates. To fight the worst economic crisis since the 1930s, the Fed has injected the most liquidity ever into the economy in its 96 year history. The result has been a Federal Funds rate between 0% and .25%. Much of the Dollar weakness is due to the “carry trade,” borrowing Dollars at extremely low rates and selling them for currencies yielding more; for example, Australia’s benchmark lending rate is 3.75%.
At some point the Federal Reserve may increase the Federal Funds rate as our economy rebounds. That increase may be sudden and substantial. At that point those engaging in the carry trade may worry that when they need to rebuy the Dollar to repay their cheap loans, the US Dollar may have appreciated, plus of course their loan’s interest rate may have risen. The inevitable unwind of the carry trade will boost the Dollar substantially.
Unless you believe that US interest rates will not rise, you must brace for higher rates driving the Dollar up.
3. Investors May Embrace the Dollar Should the Global Economy Hiccup
During the financial crisis precipitated by Lehman’s collapse, the Dollar soared in value as investors focused more on return of principal than return on principal. Investors rushed to trade out of risky assets, like commodities, overseas borrowers, even foreign currencies, to repay their Dollar loans. In the same way that the worries engendered by 9/11 brought assets to the US, if we should have another financial crisis investors may once again line up to transfer their assets to America, driving up the Dollar in the process.
The recent debt moratorium announced by Dubai World underscores the risks still lurking in the global economy. In the wake of that announcement the Dollar jumped as investor grew fearful of overseas risks.
Unless you believe that the global economy has completely recovered from the “Great Recession,” you need to brace yourself for a rush to the Dollar following the next shoe to drop in this global financial crisis.
4. The US Economy May Strengthen
Even if the global economy doesn’t hiccup, if the US economy gains strength, our interest rates will tend to rise, investor interest in the US will increase, and concerns over the Federal budget deficit will decrease. All of this will make the Dollar a more desirable currency, boosting its price.
A number of metrics suggest the United States is emerging from recession. For 2009’s third quarter we reported our first growth in our Gross Domestic Product after four straight negative quarters. The housing and auto industries are recovering. November’s jobs report showed a net loss of just 11,000 jobs, the smallest since the start of the recession and the biggest one month decline in more than three years.
This will boost interest rates by increasing the demand for funds as borrowers grow more optimistic about the future. Overseas investors will buy Dollars to take advantage of our improved outlook. Tax receipts will increase, placing our Dollar less at risk from our budget deficit.
So, before you effectively short the Dollar when investing consider the implications of a strengthening US economy.
5. The Commodity Bubble May Lose Air
Commodities have been on a tear, perhaps even entering into a bubble phase, despite a very weak global economy. Because commodity prices are cyclical and their price movements seem not to be supported by fundamental demand, a reversal in their prices may be at a hand. Commodities and the value of the Dollar are generally inversely correlated; a top in commodity prices may signal a halt to the Dollar’s decline.
Gold has soared 387% over the last 10 years, and is up 32% this year alone. Copper has more than doubled in 2009. Oil is up nearly 8 fold since 1999.
Investors should watch commodities closely in 2010. Their retreat may coincide with the Dollar’s rise.
Investment Implications
Dollar denominated assets will perform better than non Dollar denominated assets should the Dollar strengthen. This would raise the risks for overseas stocks and bonds.
Among Dollar denominated assets, those with little overseas exposure could trump so called US multinationals, such as McDonalds. Economic sectors with less overseas exposure would include small cap stocks, utilities, banks, and retailers.
Sectors of the economy reliant on rising commodity prices may struggle relative to sectors somewhat insulated. Natural resource companies, including energy and mining concerns, may suffer from lower than anticipated revenue streams. On the other hand, the health and technology sectors may see no ill effects if the Dollar strengthens and commodities cheapen. Transportation companies, like the rails, autos, and airlines would undoubtedly benefit from the Dollar purchasing more units of energy.
David G. Dietze, JD, CFA, CFP™
President and Chief Investment Strategist
Point View Financial Services, Inc.
Summit, NJ
e-mail: [email protected]
