Where next for the US dollar?

The pound’s steady decline since the UK’s referendum on EU membership has reminded investors just what an impact currency can have on investment returns.

While the pound has been depreciating, the path of the US dollar has not been so clear cut in the past year.

Haven of choice

Russ Mould, investment director at AJ Bell, observes: “The dollar has done its usual thing – rise in anticipation of interest rate cuts and then sag when the increases in headline borrowing costs are actually pushed through by the US Federal Reserve.

“The DXY, or Dixie, trade-weighted dollar index has basically gone sideways for two years and, frankly, that’s a good thing: a rising dollar tends to slow global growth, as it makes commodities more expensive and servicing overseas dollar-denominated debt more costly.”

He predicts that if or when there is another global financial crisis, the US dollar is likely to be “the haven of choice” again.

Valuations being less extreme than a year ago suggest the dollar’s decline will be rather more pedestrian in 2018 than it was in the first half of 2017.John Bilton

Currency predictions are almost impossible to make but commentators can make some educated guesses based on the likely trajectory of interest rates – at least that’s what Rathbones’ David Coombs thinks.

He forecasts: “We believe it [the dollar] should resume its upward trend against its major trading partners in 2018, especially if the three interest rate hikes hyped by the Federal Reserve come to pass. 

“Pulling the trigger on all three seems unlikely at the moment, but movements in Fed funds futures suggest that investors believe tax cuts will make tighter monetary policy more likely.”

But John Bilton, head of global multi-asset strategy at JPMorgan Asset Management, insists the days of Fed policy having any real effect on the dollar are over.

“While it is true that the US is well ahead of other regions in raising rates, it is no longer the case other central banks are rowing in the opposite direction,” he explains. “This blunts the impact of Fed policy on the dollar and leaves global growth differentials to dictate the path for the currency.”

Mr Bilton continues: “In an environment where growth relative to trends in the eurozone, Japan, and parts of the emerging markets compares favourably to the US, the dollar looks set to gradually soften. 

“Valuations being less extreme than a year ago suggest the dollar’s decline will be rather more pedestrian in 2018 than it was in the first half of 2017, but the direction of travel is the same.”

Ryan Paterson, research analyst at Thesis Asset Management takes a similar view on the dollar’s direction this year.

“We think the dollar remains firm through the first half of 2018 but as policy normalisation in places like Europe and perhaps even Japan regain focus, and as the dollar increasingly sees late-cycle fatigue, it may give up those gains through the second half of the year,” he says.

Currency hedge

What does it all mean for UK investors with US exposure?

Mr Paterson points out UK investors can mitigate currency movements when investing in the US by buying hedged share classes or hedged exchange-traded funds, but adds “it’s worth pointing out there are costs associated with hedging”.

It is up to an adviser’s client to decide whether they want exposure to any currency risk at all.

When investing, it is not only the currency of the country in which you are investing to be mindful of, but also the domestic currency.

Guessing where the pound might end up this year is difficult, let alone where it will be once the Brexit negotiations are finalised.

“Inflationary pressures are increasingly in the making, and this weakens the pound structurally,” notes Viktor Nossek, director of research at WisdomTree in Europe. 

“Irrespective of the fundamentals underpinning the dollar, these are risks UK investors will be exposed to when investing in overseas assets. 

“A currency hedged overlay would help shield investors from FX risk, while still enjoying the upside in dollar or emerging market assets.”

Pound versus dollar

Those with more confidence in their knowledge of currency movements, usually more sophisticated clients, may want to bet on the pound versus the dollar.

Mr Mould suggests: “Pound down, dollar up has been a big part of the FTSE 100’s post-EU referendum advance, so one hedge against dollar strength is to buy the FTSE 100’s multinationals, via an active or passive fund.

“Anyone with exposure to US assets who fears a dollar decline can reduce their positions and bring cash back home or buy a currency-hedged fund.”

There is so much political risk here at the moment that I'd view holding funds invested overseas as a good option.Darius McDermott

He cautions: “But these collectives tend to come with higher fees and you are not guaranteed to be right in your view on the sterling/dollar cross-rate, as getting forex right is even harder than stocks, in my view.”

Darius McDermott, managing director at FundCalibre, suggests a bit of currency exposure in a portfolio can be helpful during periods of volatility.

"There is so much political risk here at the moment that I'd view holding funds invested overseas as a good option," he says. "If the dollar does well against the pound, UK investors will get an uplift and if it does badly, although returns would be less, it would signify things here are improving, so good news anyway."

If an investor has any doubts whatsoever, then avoiding a currency play altogether is the best route.

Mr Mould confirms: “Ultimately, I wouldn’t let your views on forex colour your views on the underlying assets too much as the currency markets are just so unpredictable.”

eleanor.duncan@ft.com