With US president Donald Trump having (at least temporarily) postponed a financial stimulus package, the collapse in US domestic savings, current account deficit and the US Federal Reserve’s determination to maintain a long-term flat interest rate, concerns are flying that the greenback's value could decline over the medium term.
The US Dollar Index, which tracks the greenback against a basket of other major currencies, has dropped 6.15% in the past six months, even though the US dollar remains the most overvalued currency in the world and stay as a safe haven for investors.
The currency's recent surge will last less than three months, according to a majority of foreign exchange strategists polled by Reuters, who said the greenback would have a roller-coaster ride in the run-up to the US presidential election.
“Since valuations are not in the greenback’s favour, we estimated the dollar is about 15% overvalued against a basket of currencies,” Luca Paolini, chief strategist from Pictet Asset Management, told AsianInvestor.
That is forcing investors to consider how best to respond, in terms of their asset allocations. Andrew Zurawski, associate director from Willis Towers Watson, warned that they consider carefully the level of risk they can tolerate, maximising portfolio diversity and removing unrewarded risks.
AsianInvestor asked eight experts about how a weakening US dollar would affect the investment climate and how institutional and other investors should rebalance their portfolios. Emerging market assets and gold are among their key picks.
The following contributions have been edited for clarity and brevity.
Vincent Mortier, deputy CIO and Asia ex-Japan supervisor
The dollar has been experiencing a cyclical weakening. Over the last two years, the dollar bull market had been supported by large interest rate differential and above-trend growth relative to the rest of the world.
Since the pandemic-induced recession, we have seen the removal of the twin pillars that used to support the dollar – interest rate differentials and US growth exceptionalism – replaced by the re-emergence of the twin deficits, especially the fiscal deficit.
Therefore, we expect the dollar to stay weak in the medium term. Investors should stay neutral on risk assets (slightly cautious on equities, positive on quality credit) but remain watchful to identify opportunities, book profits where the upside seems limited and maintain appropriate hedges.
On FX, we believe investors should favor a diversified basket of high-yielding emerging market currencies amid improving growth dynamics, light positioning and rising inflows into the region.
Sukumar Rajah, director of portfolio management for emerging markets equity
Franklin Templeton Investments
In the near to medium term given global economic uncertainty, low US inflation expectations and the continued importance of the USD as the global reserve currency. The weaker US dollar is beneficial for Asian equities.
Beyond currency, the case for Asian equities is strong. North Asia’s containment of Covid-19 will lead to faster macro normalization versus other regions. Beyond Covid, China’s growth is underpinned by a diversified domestic economy driven by innovation and digitalisation, whereas Taiwan and Korea are beneficiaries of the structural growth in tech hardware as well as the diversification of the global tech supply chain.
Asean and India have lagged in terms of Covid normalisation but are gradually re-opening with macro recovery supported by favorable demographics. (Young population leading to lower mortality rates.) We are positive given demographic tailwinds, the improving case for foreign direct investment (improving regulatory regimes and the diversification of existing global supply chains), and the significant scope for consumption growth from low base.
Paul Sandhu, head of multi-asset quant solutions for Asia Pacific
BNP Paribas Asset Management
The weakening of the US dollar could be a positive for the overall global investment climate. The first and most important reason being diversification. Because of the bull equity market in the US and the off-again-on-again utility of the market as a “safe haven”, over the last decade global portfolios have become more concentrated in their US allocation and this has led to elevated asset correlations in that market.
Going forward, we must have more globally diversified portfolios and the US dollar depreciating versus emerging market currencies will provide a positive effect on that diversification trade.
On the other hand hedging costs are low right now. This means that global diversification does not have to come with currency risk. In fact, for Asian investors many domestic investors such as in China, get a substantial yield pick up just from hedging US dollar back to the renminbi.
Luca Paolini, chief strategist
Pictet Asset Management
There are several trends have supported the US dollar in the nine years since it hit an all-time low in trade-weighted terms: superior economic growth, yield support from higher interest rates, a cheap valuation and strong international demand. The greenback’s problem now is that some of these trends have already reversed.
First, the US economy should continue to grow faster than the rest of the developed world, but the gap will narrow steadily over the next five years. Secondly, the dollar will also have to contend with reduced yield support. The differential between US rates and those in the rest of the developed world has shrunk from 200 basis points in the summer of 2019 to nearly zero.
Against emerging market currencies, the dollar’s downside will be more pronounced, supporting emerging market assets more broadly. We see the prospect of a stronger renminbi for several reasons: valuations are cheap, China’s inflation is under control, monetary expansion to slow over the coming years.
Alicia Garcia-Herrero, Asia Pacific chief economist
Beyond the fact that American exporters are not very sensitive to the value of the dollar, the most important reason is its increasingly challenged reserve currency role.
Such a challenge cannot yet be seen in the figures, as the number of dollar-denominated assets, as well as cross-border settlements, continues to increase. But major central banks around the world, clearly that of Russia but also apparently China, are reducing their holdings of dollar-denominated assets.
In addition, the amount of debt which the US managed to pile up before, and even more so after the pandemic erupted, makes the prospects for the value of the dollar shakier.
Such a situation makes it very dangerous for the US to play the weak dollar card, which in any event may not have major benefits anyway. This, however, does not mean that a sudden appreciation of the US dollar, following a sharp increase in risk aversion from a risk-off environment is any better. Ideally, the dollar should remain stable or strengthen somewhat as the signs of rapid economy recovery continue to pile up.
Quentin Fitzsimmons, senior fixed income portfolio manager
T. Rowe Price
The Federal Reserve has effectively affirmed an ‘ultra low for longer’ interest rate strategy that skews the target range for inflation to the upside – this will likely put pressure on the dollar. Another potential drag on the dollar is the Fed’s stimulus programs.
The programs supply the market with ample liquidity, which will likely keep the dollar under pressure. Fiscal deficits will rise as a result of the Fed’s ongoing action, and in the past, this has been negative for the currency.
We are particularly interested in emerging market currencies that display a reasonably attractive profile combined with a low volatility structure, such as the Indian rupee. On the other hand, there are other emerging market currencies that are at risk of political disruption. The Chinese renminbi, for example, is a candidate to implement a short position as a hedge against a possible rise in tensions ahead of the US presidential election.
David Chao, global market strategist for Asia Pacific ex-Japan
The US Dollar Index has recently strengthened on the back of an improving US economy as well as a flight to safety ahead of a sure-to-be tumultuous presidential election. Taking this short-term aberration in stride, I expect the US dollar to weaken after the US president is inaugurated early next year and for the dollar to remain weak over 2021.
US currency weakens relative to other currencies – if we look at other central banks’ balance sheets around the world over the past 12 months, the Fed has been exceedingly more active than others in growing its balance sheet, for example almost twice the People's Bank of China and 50% more than the European Central Bank.
With this backdrop, I think it makes sense for investors to diversify away from dollar and dollar-denominated debt into currencies with the best chance of appreciating against the dollar, such as emerging market Asia currencies.
Emerging Asia equities appears to be the most likely asset class to outperform in the event of a weakening US dollar and a possible pick-up in the US economy next year due to fiscal stimulus measures.
John Sidawi, global fixed income portfolio manager
Recently, the US dollar was stripped of some of the main pillars that kept it resilient. However, it is still the world’s premier reserve currency and will likely remain a safe haven for investors. Consequently, the dollar is beginning to look increasingly like a hedge against volatility and very little else.
On some metrics, the currency is still over-valued by an average of 10%, but “over-valuation” is a subjective measure, especially when everything was working in the US dollar’s favour.
For the past two years, foreign ownership of US assets has been decelerating, but US investors had little incentive to seek value beyond their own shores. Just a small modification in this strong home bias could ultimately end this three-year bullish US dollar trend.
That is forcing investors to consider how best to respond, in terms of their asset allocations.