The recent reversal in the strength of the US dollar, driven by expectations of falling inflation and potential interest rate cuts by the Federal Reserve, has significant implications for investors.
The recent moves will be welcomed to central bankers around the world, who have been struggling to deal with rising US Treasury yields and the dollar’s continuos strength.
That has particularly been the case in Japan, where the ministry of finance is thought to have sold around $59bn of dollars in recent weeks to support its ailing currency.
As the dollar’s strength wanes, investors must adapt their strategies to take advantage of the opportunities and mitigate the risks associated with this shift.
Here are my key considerations and strategies for investors in this changing landscape:
Understanding the drivers
The US dollar had appreciated significantly earlier in the year, buoyed by higher interest rates and a robust economic outlook.
However, as inflation begins to ease and the Fed considers cutting interest rates, the dollar’s appeal has diminished.
Lower interest rates typically reduce the return on dollar-denominated assets, making them less attractive to investors. This shift is now leading to a depreciation of the dollar against other major currencies.
Implications for international investments
A weaker dollar can have a profound impact on international investments.
For US-based investors, foreign assets become more attractive as their returns in dollar terms increase when the dollar depreciates.
Conversely, for investors holding US assets in foreign currencies, the value of their investments may decline in their local currency terms.
Investors should consider increasing their exposure to equities and bonds outside of the US. Countries with stronger currencies and improving economic fundamentals can offer better returns as the dollar weakens. European and Asian markets, for instance, might present lucrative opportunities given their current economic trajectories.
For those already invested in non-US assets, it’s crucial to reassess currency risk. Hedging strategies, such as using currency futures or options, can help mitigate the potential adverse effects of a declining dollar on international investments.
Impact on commodity prices
Commodities are typically priced in dollars, and a weaker dollar tends to push up the prices of commodities like oil, gold, and agricultural products.
This relationship occurs because a depreciating ‘greenback’ makes commodities cheaper for holders of other currencies, boosting demand and prices.
Effects on US exports and imports
A weaker dollar makes US exports cheaper and more competitive in the global market while making imports more expensive. This dynamic benefits American companies that export goods and services, potentially boosting their revenues and profitability.
Investors should look for opportunities in sectors that benefit from increased exports, such as tech, manufacturing, and agriculture. Companies with significant international sales will likely see enhanced performance in a weaker dollar environment.
Conversely, companies heavily reliant on imported goods and materials will face higher costs, squeezing their profit margins. Investors should be cautious about sectors like retail and automotive that may be adversely affected by rising import costs.
Evaluating emerging markets
Emerging markets will typically benefit from a weaker dollar, as it eases their debt burden and improves liquidity conditions. Many emerging market countries have significant dollar-denominated debt, and a depreciating dollar makes it easier for them to service this debt.
Investors might consider boosting their allocation to emerging markets, which could offer attractive returns as their economic conditions improve in response to a weaker dollar.
However, while the overall outlook for emerging markets may improve, it’s essential to evaluate country-specific risks and opportunities. Political stability, economic policies, and growth prospects vary significantly across emerging markets.
By staying informed, and working alongside an adviser, investors will be best-positioned to seize the opportunities of the shifting currency environment.
Nigel Green is deVere CEO and Founder
Also published on Medium.
