27 September 2019
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Quentin Fitzsimmons, portfolio manager of the T. Rowe Price Dynamic Global Bond fund, outlines the five key themes investors must monitor over the near term.
Rate cuts do not always trigger dollar weakness
Interest rate cuts are usually associated with currency depreciation, but that has not always been the case for the US dollar. In fact, during the last four US rate‑cutting cycles, the dollar has only weakened on one occasion.
With this in mind, going underweight the dollar because the US Federal Reserve is expected to cut could be a dangerous game. There are many other factors needed to be taken into consideration.
Growth differentials drives dollar more than growth
The dollar has remained strong this year despite the slowing US economy. This is because the way the US economy performs relative to other countries influences the currency more than US growth per se.
So far in 2019, European growth has disappointed more than US growth. Italy’s economy, for example, stagnated in the second quarter, while the UK experienced a contraction in the three months to June.
Perhaps more importantly, in Germany – Europe's largest economy – the manufacturing sector is suffering a recession as trade tensions weigh on export demand.
Unless the differential between the two major economies reverses, it is difficult to see how the dollar can significantly weaken against the euro.
Dollar remains attractive from a carry perspective
In the developed market space, investors can earn one of the highest carry rates by the US dollar.
Despite recent rate cuts, the dollar is likely to remain attractive for some time from a carry perspective – this is because US rates are so much higher than places such as Japan and Switzerland, where rates are negative.
That said, when hedging costs are considered, US dollar‑based assets can be less appealing for foreign investors.
On the surface, for example, US 10‑year treasuries appear much more attractive than 10‑year German bunds, but the yield advantage effectively disappears if the cost of hedging dollars back to euros is taken into consideration.
Tariffs create currency volatility not direction
The impact of tariffs on currencies is difficult to assess. While protectionism should be supportive of the local economy, an efficient market will simply undo the impact to the terms of trade caused by a tariff, sometimes encouraging the protected country’s currency to actually appreciate.
Indeed, this may have been an unintended consequence of President Donald Trump's strategy. Following a particularly difficult round of tariff negotiations, Chinese authorities recently let the renminbi fall to its weakest level against the dollar in more than a decade, but kept its value versus a broad basket of other currencies relatively unchanged.
Currencies are increasingly being used as political tools, and as the trade negotiations between the two sides go on, we may not have seen the last of the measures. Against this backdrop, volatility is expected.
Perhaps the best way to benefit from this is through the use of currency options.
Safe‑haven status of the dollar remains intact
In times of stress, investors flock to the US dollar – a trend that looks unlikely to change anytime soon. The US dollar is where liquidity ends up being trapped in this low-yield environment.
This trend is amplified by the inversion of the US treasury curve, as parking cash in money market funds has become much more attractive now.
Although the Swiss franc and the Japanese yen have been well bid this year as uncertainty has increased, the dollar remains king for investors looking for safety.
This is unlikely to change.
The US dollar has proved resilient so far this year, despite a slowing domestic economy.
The US dollar has proved resilient so far this year, despite a slowing domestic economy. Quentin Fitzsimmons, portfolio manager of the T. Rowe Price Dynamic Global Bond fund, outlines the five key...
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