The US dollar has been strengthening during the past six months, while the tumbling price of oil and the potential for a Greek exit from the eurozone have been dominating recent headlines.
The increased commodity volatility has not gone unnoticed by investors but the notable volatility in currencies has not been quite so well documented.
The US currency move has been so pronounced that it was commented on by the Federal Open Market Committee (FOMC) in its January meeting, the minutes show.
The FOMC observes: “The US dollar strengthened against the currencies of most other advanced economies amid investor concerns about growth in those economies, as well as increased monetary accommodation in some of them. On average, the dollar was largely unchanged against the currencies of emerging market economies.”
Simon Clinch, US equities fund manager at Invesco Perpetual, points out: “The fourth quarter of 2014 saw a sudden explosion of volatility in commodities, currencies and stocks, entirely driven by external factors.
“Oil prices have fallen by more than 40 per cent from last year’s highs. The Vix index – a measure of equity market volatility – spiked to levels not seen since the euro crisis in the latter half of 2011. And the US dollar rallied hard against virtually every major floating currency.”
He adds that since the end of June 2014 to the end of January this year the trade-weighted US dollar gained nearly 19 per cent.
Data from FE Analytics for the 12 months to February 18 2015 shows the US dollar gained 8.36 per cent against sterling. However, against the Japanese yen it rose by 16.4 per cent, while the greenback surged 21.31 per cent versus the euro.
Paul Lambert, head of currency at Insight Investment, thinks this is only the “first phase” of the strengthening dollar.
He explains: “Our view is that there’s certainly scope for a continuation of the move. It’s not just that it’s moving, it’s that currency volatility generally – including dollar volatility – has picked up.”
For investors in US equities, he advises: “What the increased volatility in currency markets is doing – especially in the context of higher valuations in equity markets and lower returns – means that you need to make two decisions: you need to decide about what you want to do with your equities, and you also need to make a decision about what you want to do with the currency exposure that having those equities entails.”
Mr Lambert continues: “We don’t think it’s the end of the dollar move, we think there’s more to come. Therefore, we think if you haven’t made a decision about currencies up until now, it’s not too late. You still need to make a decision because these moves are likely to persist.
“If you’re trying to ignore currency, there’s more risk, and if you’re engaging with currency, there’s more opportunity.”
UK investors in US equities will need to consider the impact on their portfolios if they invest through their local currency. Spike Hughes, chief executive of Cohesion Investments, suggests that a stronger dollar makes exports more expensive.
He notes: “If you’re an investor in the UK buying a US equity fund, and if the dollar strengthens and you’re buying a fund but it’s priced in sterling, then if sterling becomes weaker you’ll get more pounds when it prices in your currency because your own currency is weaker and that can give you a performance boost.”
But Mr Clinch cautions that US businesses that sell products abroad have two choices: to hold local pricing at the expense of margins, or raise local pricing to protect margins, which he acknowledges will impact demand.
He says: “The strong US dollar has the potential to expose the true pricing power of US businesses in foreign markets, and I expect there to be some negative impact on demand expectations as we progress through the next few months.”
The Federal Reserve seems to be preparing markets for an interest rate rise later this year, with some economists forecasting that this may happen around the mid-point of the year.
Mr Lambert adds: “This dollar strength hasn’t come from the market becoming more hawkish on the US. On the contrary, the market has become increasingly less hawkish on the US but even more dovish on the rest of the world.
“We think the Fed will stick to the plan it has outlined in the past, which is one that will result in the tightening of policy, and we think that’s going to support the dollar strength going forward.”
Ellie Duncan is deputy features editor at Investment Adviser
