Insights   •   Currency

US Dollar: How to Position for the Longer Term Bear Market Trend

  • Shorter term currency volatility and corrections are likely to continue.
  • Longer term the United States (US) dollar downtrend continues.
  • Risk assets should continue to rally as the global recovery from the pandemic continues.

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

Implementation Ideas

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:

SPDR® S&P®/ASX 200 Fund (STW)

SPDR® S&P®/ASX 200 Financials EX A-REIT Fund (OZF)

SPDR® S&P®/ASX 200 Resources Fund (OZR)

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:

SPDR® S&P® World ex Australia Hedged Fund (WXHG)

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:

SPDR® S&P® Emerging Markets Fund (WEMG)