But not everyone is convinced a European version of QE would weaken the euro and, in the meantime, the strength of the euro and sterling against the dollar (and emerging market currencies) is having a major impact on investments.
About 16 FTSE 100 companies pay dividends in dollars, so the fall in the dollar has hurt sterling-denominated income funds.
Fadi Zaher, Kleinwort Benson’s head of bonds and currencies, says some global income-seeking investors have been caught off guard, given the speed at which the pound has appreciated against major currencies and has wiped large fractions off dividends paid in the past year.
Philip Lawlor, Smith & Williamson economist, says the problem for investors is gauging how much of their fund exposure is hedged, at what level and for how long.
He says UK-based investors can take out a hedging strategy themselves or hope that companies, for their net exposure, have done some hedging.
But to employ a hedging strategy themselves, fund managers need a high degree of conviction because of the extra costs. That’s because if the currency move does not happen, they will have inferior returns, all things being equal.
“Fund managers need to have a very clear view on currencies and be very explicit about buying the hedged fund classes,” Mr Lawlor explains.
The rise in the euro and sterling has also underscored the benefits of investing locally, with small- and mid-cap funds having outperformed in the past few years, as they have benefited from being more domestically focused than large-cap funds.
The FTSE 100 index has significantly underperformed other global equity benchmarks on a local currency basis. This may be due to 70 per cent of FTSE 100 companies having overseas earnings, compared to 49 per cent overseas exposure for the S&P 500.
Mr Lawlor adds that a strong sterling “could also exacerbate our disinflationary headwinds”.
This would happen where commodities priced in dollars are not going up and the UK ends up importing deflation into a retail environment that is heavily discounting already.
An acceleration in disinflation in the UK would mean that the chance of rate hikes are pushed back and would point to some lowering of growth rates.
However, Mr Lawlor recommends taking a trade-weighted view of sterling, saying that sterling’s current appreciation is not at such an extreme level that it is making UK companies uncompetitive.
“Sterling has risen 12-13 per cent from its low point a couple of years ago, but in terms of its trade weight, sterling is about 15 per cent below where we were in 2008. We would need to see trade-weighted sterling go back above the 2007-08 peak for it to undermine the manufacturing recovery.”
Looking ahead, the actions of the ECB will be key. The euro is overvalued and its appreciation is causing a serious deflationary threat.
If the euro fell to €1.25 against the dollar, compared to roughly €1.36 it is now, such a fall would pull down sterling, making FTSE 100 companies more attractive compared to small- and mid-cap companies.
Mr Lawlor expects the US to raise rates before the UK because if the US unemployment rate falls to near 5 per cent, the Federal Reserve will be forced to change its messaging on rate hikes.
“Janet Yellen [Fed chairwoman] can’t be seen to be behind the curve,” he explains.
“She’s come out as dovish, but she may be forced to change. If there’s a sense in Q3 that US interest rate expectations will be brought forward and the UK’s pushed back, this will help undercut sterling.”
If this is followed by QE from the ECB later in the year, he says there will be a much greater supply of euros in the system, relative to the supply of dollars, marking a significant turning point in the currency markets.
“If the US gets another strong labour market release, it could be Q1 2015 when the US tightens monetary policy.”
So what are fund managers expecting? Sandra Crowl, a member of the Carmignac investment committee, thinks a better growth profile in the US in the second half of 2014, with potentially some early anticipation of predicted 2015 rate rises, should favour the dollar versus other currencies, particularly the euro.
Meanwhile, Stewart Cowley, Old Mutual Global Investors’ investment director for macro and fixed interest, thinks the euro/dollar rate should be $1.25, not $1.36.
As for sterling, he says it should be at roughly $1.60 and not $1.70. His Global Strategic Bond fund has about 30 per cent in the dollar, waiting for it to rise against the pound in the second half of the year.
Roger Hallam, JPMorgan Asset Management’s currency chief investment officer, says if recent ECB measures to strengthen eurozone growth are successful, it could be positive for European asset valuations and higher yielding fixed income sectors.
But currency forecasts are notoriously difficult to get right. A wide range of factors can impact rates, and fluctuations in currencies can be triggered by completely unexpected events.
