The stock market rally of the last few months may have revived investor appetite, but the matching decline in the dollar has gathered fewer headlines. It could mark the start of a very different period in financial markets, where US assets are no longer as dominant and leadership broadens out. But who would benefit if the dollar continues to fall?
With the caveat that the dollar has defied previous predictions of weakness, there are reasons to believe that a decline in the greenback is plausible in the year ahead.
The strength of the dollar is premised on its status as the world’s reserve currency, the US’s position as the world’s largest economy and the strong creditworthiness of the US government.
All of these factors are under threat to some extent. The level of US national debt is a significant concern. It currently sits at nearly $33 trillion dollars and almost 100% of GDP. It has risen almost 90% since the start of the pandemic and neither of the likely presidential candidates appears minded to tackle it. The Republicans want to cut taxes, while the Democrats want to raise spending.
This is a threat to US economic stability. The annualised interest bill has hit $1 trillion, or 20% of tax income. Not only does this stymy government investment spending to boost the economy but it also creates the longer-term risk that the US loses its status as a good creditor, which pushes up its cost of borrowing.
While the US could rely on its own central bank to buy the debt, this wasn’t a problem, but it is now at the mercy of more discerning buyers on international markets.
Is the US dollar losing dominance?
There is also the phenomenon of ‘dedollarisation’. It is still the case that the majority of global trade happens in dollars, particularly in commodities markets. However, the growing power of China on the international stage and the sanctions imposed on Russia have seen more intra-emerging market trade conducted in alternative currencies.
In Latin America, for example, there is increasing commodities trade using the Chinese Renminbi. JPMorgan research finds that dedollarisation is particularly evident in FX reserves.
Another problem for the dollar may be US febrile politics. The electoral choice between the unpredictable Donald Trump and the frail Joe Biden is as unpalatable internationally as it is for many domestic voters. The volatility surrounding the election does little to boost confidence in the US currency.
Investment implications
While it is by no means the whole story, the strong dollar has been a powerful support for the outperformance of US assets over the past decade. The S&P 500 index hedged back into sterling has delivered an annualised return of 15% over the past 10 years, compared to 12% for the non-hedged version, where investors got the full impact of the rising dollar. It has added to the popularity of US assets.
The strong dollar has also been beneficial for companies that generate significant dollar earnings, whether they are based in the UK, US or Europe. This includes many of the UK’s largest companies and, in particular, its largest dividend payers. The latest Computershare UK Dividend Monitor found that a stronger pound had shaved around three percentage points off the UK’s dividend growth rate in the third quarter.
In looking for those areas that may benefit from a weaker dollar, it is often difficult to disaggregate the impact of currency. Investors may fully or partially hedge their currency exposure and individual funds may also hedge. However, in general, it will give some breathing space to those areas that have struggled under a rising US dollar over the past decade.
That includes emerging markets, which are often reliant on foreign investment and foreign capital. They can be ‘crowded out’ by a strong dollar which, if it coincides with higher interest rates in the US, makes it harder for emerging countries to pay back their dollar-denominated debt.
At the same time, emerging markets need to buy energy in dollars to support their growth. Capital equipment may also be priced in dollars. This was a particular problem for countries such as India with relatively few sources of dollar revenue.
A weaker dollar reverses this pressure for many emerging markets. Funds such as the GQG Partners Emerging Markets Equity fund, which has high weightings in India and Brazil (29% and 25% respectively) may be a beneficiary.
Although India is expensive, its election is one of the more predictable this year and a weaker dollar could help an economy that is already buoyant. The GS India Equity Portfolio would be a good country specific-option.
Another beneficiary could be those US and international companies that derive a lot of their earnings internationally, but where their expenses are in dollars. This includes companies such as McDonald’s, Coca-Cola or Apple. The Morgan Stanley Global Brands fund will hold many of these US-based, internationally focused types of company, including Visa and Microsoft.
A final, controversial option could be gold. Gold and the dollar tend to have an inverse relationship, although it is muddied by other factors such as inflation. Ninety One Global Gold is a core option worth considering.
The dollar often proves more resilient than investors expect, but US policymakers are testing that to the limits. After the past few years, investors may find themselves naturally long dollar assets and would be advised to ensure some balance in their portfolios.
Darius McDermott is managing director of Chelsea Financial Services and FundCalibre. The views expressed above should not be taken as investment advice.