Since the peak of the COVID-19 pandemic (March 2020), the US dollar has been on a downward trend. Following the view that the US dollar is in a cyclical bear market. Over 2020, the US Dollar Index (DXY, which is measured against developed market currencies) was down 6.6%. However, during the first quarter of 2020, the US Dollar Index rose over 6.5% before it began a downward trend. Since its peak in March (to the end of the year) it fell by almost 12.5%.
The start of 2021 has seen the US dollar consolidate some of those losses, with the US Dollar Index up 0.7% in January 2021. But does this mean that the longer term trend is about to reverse or is this just a short term correction? Our view is that the current relative strength in US dollar is the later – a short term correction. We expect a downward trend will resume over the longer term, but expect further short term corrections and volatility in risky assets. In January, for the most part the US dollar rallied after negative US economic news including the disappointing employment figures on the 8 January and the poor retail sales data announced on the 15 January, challenging the global recovery theme. Between the two rallies the US dollar fell back lower on positive news and expectations such as hopes that the Biden administration would eventually secure a US$1 trillion+ fiscal stimulus in Q1 and the gradual
reduction in global COVID-19 cases during the second half of the January.
As the year progresses we expect our longer-term bear market trend to reassert itself. As the global recovery develops, we expect the Federal Reserve (Fed) to maintain monetary policy settings. Steady monetary policy alongside improving growth and inflation implies effective easing as real rates fall and the output gap (the difference
between the actual output of an economy and its potential output) gradually dwindles. This further erosion of real yield support is likely negative for the US dollar.
A weaker US dollar is generally positive for high beta markets such as Australia and Emerging Markets (EM). Examining January’s performance, we see that US dollar performance was predominantly against the G-10 markets, and whereas EM could provide a bright spot for investors.
Source: State Street Global Advisors, Bloomberg Finance L.P., as of 29 January 2021.
So if we expect further long term weakness in the US dollar, what exposures might investors
These themes may help investors seeking to position for the longer term US dollar bear market.
In a risk on environment, we expect Australian equities which thus far have lagged international equity markets in the market recovery to perform well. High exposure to cyclical sectors such as Resources and Financials should benefit as the reflation/recovery trade comes through. Gain exposure through the:
International equities still provide attractive diversification benefits for investors but with the US constituting approximately 60% of the MSCI World ex Australia Index, investors should consider hedging part or all of their international equity exposure with:
The recent consolidation in the US dollar has mainly been against the G-20 developed market currencies, while performance has been more mixed against EM currencies. In particular, the outlook for China, which makes up almost 40% of the MSCI EM Index still looks positive and the Chinese Renminbi has held up well against
the US dollar. EM earnings are looking to follow developed markets and beat consensus expectations while the growth recovery is supportive of EM strategies such as:
The views expressed in this material are the views of Raf Choudhury through the period ended 31 January 2021 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Investing involves risk, including the risk of loss of principal.
Risk associated with equity investing include stock values which may fluctuate in response to the activities of individual companies and general market and economic conditions.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
Companies with large market capitalizations go in and out of favor based on market and economic conditions. Larger companies tend to be less volatile than companies with smaller market capitalizations. In exchange for this potentially lower risk, the value of the security may not rise as much as companies with smaller market capitalizations.
Currency Risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged. Currency Hedging involves taking offsetting positions to reduce exposure to different currencies. These currency exchange contracts may reduce or eliminate some or all of the benefit that an investment may experience from favorable currency fluctuations.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.