Will the US walk the dollar down?

Graham Smith, Market Commentator, 20 April 2017

President Trump’s apparent change of tack, from criticising China’s currency as too low to saying the US dollar is too high, has been seized upon by markets. Could the new US administration actually weaken the dollar?

It’s unlikely that the benefits of a weaker currency have passed Donald Trump by. His election campaign featured constant criticism of the low exchange rate chosen by China. As a self-professed fan of Brexit, and following the recent fall in sterling, he will be aware as well of companies from over here doing rather well over there, to paraphrase the 1980s slogan of British conglomerate, Hanson plc.

Yet the President’s comments to the Wall Street Journal last week centred not on the currency weakness of others but what he sees as an overly strong dollar¹. The timing may be significant. If the US could defrost relations with China, that might pave the way to a deal on North Korea.

It’s worth considering what might be at the new US administration’s behest, because a weaker US dollar would find favour among manufacturers both in and beyond America’s rust belt, and importantly in the President’s voter heartlands.

Returning the focus to the possibility of punitive trade tariffs on goods from Asia could have an effect. The threat alone might persuade Asian countries to allow their currencies to drift higher in an attempt to fend off tariffs.

One substantial problem with this is the now pressing need to build better relations with China and it’s doubtful that a policy of additional tariffs on Asian goods except for those from China would be either workable or effective.

A more direct way would be to instruct the US Federal Reserve Bank to intervene in global currency markets by selling dollars. Unfortunately, walking the currency down this way is fraught with hazards.  It would open the US to charges of currency manipulation and even make other countries more comfortable with their own competitive currency positions.

Overarching all of this is the dollar’s safe haven credentials in times of economic or geopolitical stress. As Japan has found during its long drawn out recovery, engineering a competitive exchange rate is never easy when your currency is regarded as a safe haven.

Coincidentally or not, markets may be starting to discount a number of potential developments to counter dollar strength. The dollar started on a downward tack in January and President Trump’s comments last week may have done nothing more than press an established trend a little further².

The President’s apparent inability to push through his Obamacare replacement bill, even with Republicans in control of both houses of Congress, shocked markets late last month. They had been looking forward to financially positive but equally contestable legislation – tax reforms and a massive injection of government cash into infrastructure.

The European Central Bank could help by partially relinquishing its policy of easy money. A rise in interest rates from an historic low point might seem appropriate given that the eurozone now seems to be on a sustainable path to recovery. This week’s updated growth forecasts from the IMF show the eurozone growing by 1.7% this year and by 1.6% in 2018³.

So it might seem, after all, an economically as well as politically good time for the president to push for a weaker dollar. A success is a success after all, wherever the impetus actually came from.

Against all of this though lies the Federal Reserve Bank, with its main charge of keeping inflation in check even as labour markets return to full strength. It is the only major central bank with multiple rises in interest rates lined up for the next three years and to bet against additional international investment flows heading into dollar assets in such an environment could prove foolhardy.

However, should the dollar continue to weaken, that would be good news for emerging markets, particularly those with large outstanding debts in dollars. The euro too, being the dollar’s main competitor for foreign funds, could continue to shine. If the dollar was to weaken too much however, that could be worse news for both Japan and Europe, which depend on the US as a key export market.

For investors, such uncertainties offer a further illustration of the usefulness of diversification. Up until recently, support for US assets and the dollar looked nigh on unshakeable, but just a few small tweaks to market expectations can prove significant.

Much may depend in the near term on the US corporate earnings season, which needs to deliver further earnings improvements to bolster investor confidence.

The early indications are positive, with the small number of S&P 500 companies to have reported so far showing earnings improving over the same quarter a year ago⁵. However, previous dollar strength and rising energy costs are bound to get more than a passing mention this season, particularly among airlines. So the issue is far from settled yet.

Multi-asset funds can be a good choice for an investor wishing to achieve capital growth and an income over time while keeping risks down. The Aviva Investors Multi-Strategy Target Return Fund is a Select 50 fund that seeks to do this, with investments in equities, bonds property along with derivatives to profit from changes in factors such as interest rates or currency exchange rates.

For investors already with large exposures to the UK and US, a spread of investments in Europe and emerging markets with their differing upside and downside risks could be a good idea.

Fidelity’s Select 50 list includes several funds focused on these markets. Interestingly, two of these – the FP CRUX Euro Special Situations Fund and the Invesco Perpetual European Equity Income Fund – favour companies paying dividends, so could be a good choice for investors wishing to diversify their income streams as well. The Fidelity Emerging Markets Fund and the Henderson Emerging Markets Fund are among Fidelity’s most highly rated emerging markets funds.

Source:

1 Wall Street Journal, 13.04.17
2 Bloomberg, 19.04.17
3 IMF, 18.04.17
4 FactSet, 14.04.17


Important Information

The value of investments and the income from them can go down as well as up so investors may not get back the amount invested. The Select 50 is not a recommendation to buy or sell a fund. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment. Investments in small and emerging markets can be more volatile than those in other overseas markets. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment. Fidelity Personal Investing does not give personal recommendations. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.

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