Increased globalisation over the past decade has meant that currency movements have become more impo...
Increased globalisation over the past decade has meant that currency movements have become more important rather than less in a multi-national corporate world.
Ashburton Investment Managers has an active currency overload strategy with the objective of minimising risk while being exposed to the right currency at the right time.
As Ashburton's currency strategist, I believe hedging is still very profitable for investors.
Six months ago Ashburton restated a preference for the dollar and pound and said the euro could experience a recovery in 2000, but not just yet.
I also felt the yen had completed the majority of its corrective rise versus the dollar and would ultimately resume its long-term downtrend. Six months on, these views are in review.
Before we consider the future, let us assess what has happened over the past six month period. Despite clear signs of economic improvement in Europe, the euro remains out of favour and is now worth less than one dollar.
In contrast, the yen has benefited from Japan's economic recovery and has continued to strengthen versus the dollar, albeit marginally.
Meanwhile the pound and dollar have slugged it out for second place, with the dollar emerging as the winner although, again, not by a significant margin.
Dollar pound battle
Nothing has changed in the past few months to deflect us from our belief that the pound and dollar will be the strongest currencies over the long-term.
Having embarked on the path of economic reform many years ahead of their rivals, the US and UK are well placed to compete and thrive in the post-Cold War free trade era.
However, currencies never trend in a straight line, something that has been amply demonstrated by the two-year recovery of the yen.
The problem with currency analysis is, unlike other financial assets, exchange rates do not seem to conform to any hard and fast rules.
Different currencies seem to be driven by very different factors. The challenge is firstly to identify those factors and then use the information to good effect.
The value of the dollar versus the euro seems to be driven to a greater extent by stock market movements and to a lesser extent by interest rates.
The value of the yen, in contrast, is much more driven by the size of the Japanese trade balance.
The graph to the right highlights this latter point quite well. Interestingly, the Ashburton yen model suggests the recent period of dollar weakness versus the yen will end around the middle of this year.
The message of the model seems wholly logical. The yen is in something of a 'no-win' situation.
If the economy stalls, the Japanese Government, having already run up a huge budget deficit and cut interest rates to 0.1%, will be forced to push the currency lower to stimulate growth.
If, as we believe will happen, the economy continues to recover, the result will be a further reduction in the trade surplus and, ultimately, a weak yen.
The yen recovery demonstrates how much a currency can appreciate, even when locked in a long-term secular downtrend.
The yen, having fallen for four years, has now recovered for two and has retraced around three-quarters of its preceding losses.
European currencies such as the Deutschmark have been weak versus the dollar for five years and are due for a period of recovery. The question is - how do we get there?
The euro's weakness has largely been driven by movements in the stock market.
This suggests the euro will not recover, at least in the short term, until there is a sustained correction on Wall Street.
The short-term picture is not very promising in this regard, but there are clouds gathering on the horizon that lead me to believe that the next major move in the euro will be up.
Although we are concerned about the long-term outlook for the yen, the short-term trend seems to be up and most of our yen exposure is currently unhedged.
Ashburton's analysis suggests the dollar may fall as low as ¥0.96 before its up-trend resumes. The euro's downtrend remains intact and our exposure to this currency is currently hedged.
However, the euro is close to a major turning point and we are monitoring the situation for any signs of technical strength.
A decision by the Federal Reserve to increase interest rates in the US would have a positive effect on the euro.
If the US economy begins to slowdown we believe the European economy will gain momentum.
The dollar and pound have been locked in a 10% trading range versus each other for five years now - there is little to suggest that a breakout in either direction is imminent.
A comparison between sterling and the dollar shows far less volatility than there ever used to be as these economies hit recessions and booms at similar times.
Over the past five years there has been a US25c range between them which is marginal.
A similar idea was behind the introduction of the euro with the hope that the economic cycles would come into line reducing currency volatility, but this has yet to happen.
Frances Wilson is a currency strategist at Ashburton The Investment Managers