The dollar zigs when it was predicted to zag
A byproduct of the global worry over the coronavirus has been a further surge in the value of the dollar, with the Wall Street Journal Dollar Index recently reaching its highest level since last October. This strengthening, which has been ongoing since the start of the year, wasn’t supposed to happen according to many analysts. As an accompanying story in the paper noted, “investors have for years expected global economic growth to weaken the dollar, only for the currency to defy those predictions.”
Currency moves have real world implications. A strengthening dollar makes imports cheaper, but it’s generally a negative for U.S. exporters. Earnings are impacted when they’re repatriated from abroad and that, in turn, can flow through into stock multiples and equity prices, creating a challenge for U.S. investors with unhedged positions in international stocks or bonds.
That doesn’t mean ignoring non-U.S. markets, however. The diversification argument remains a strong one. Historically, the economies of Europe, Asia, and the U.S. have not moved in lockstep, meaning that an investor can potentially get exposure to different parts of the business cycle by moving part of a portfolio abroad. More recently, European stocks have quietly been posting strong returns, hitting records as they catch up to the U.S.
Currencies fluctuate, sometimes driven by long-term economic trends and at other times by short-term events, like fears related to the spread of a new virus. Sometimes politics intervenes, with Brexit being one example from overseas while here in the States, we’ve heard for a long time about President Trump’s persistent efforts to talk the dollar down. None of this is fully predictable, nor is it possible to consistently gauge the reaction of the various currencies in response.
Employing a workable currency hedge is one solution to managing this set of unknowns. As regular readers of this blog know, we favor a 50% hedged position and have coined the phrase the “hedge of least regret” to describe why we like it. It can dampen the dramatic moves up and down, while allowing investors to maintain a more consistent exposure to international markets.
Hard as it may be to believe, the U.S. has been home to relatively high interest rates compared to the rest of the world over the last several years. Those rates, in turn, tend to attract capital, driving up the dollar. That advantage may be slowly eroding, however. Back in August, there was about $15 trillion1 in global sovereign debt with negative interest rates, mostly in Europe. But by mid-February, that number had fallen to around $11 trillion.2 As rates recover around the world, the flow of money into the U.S. may slow, removing one source of support for the dollar.
On the other hand, that may not happen (which we might want to consider as an evergreen title for just about any discussion involving the movement of the dollar). Or the markets may react differently than what the experts expect. Which brings us back again to the value of hedging – it can offer mitigation of uncertain outcomes. It seems reasonable to assume that U.S. markets won’t always outperform, and that the value of the dollar will fluctuate, so that diversifying internationally can add value over time. A 50% hedged fund provides a vehicle for achieving that while mitigating currency risk.
1.CNBC, Wednesday, August 7, 2019; “Amount of global debt with negative yields balloons to $15 trillion.”
2.CNBC, Thursday, February 6, 2020 “End of financial ‘Ice Age’ will take US interest rates below zero, strategist predicts.”
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Before considering an investment in the IQ 50 Percent Hedged FTSE International ETF, you should understand that you could lose money. The Fund will invest in securities denominated in currencies other than U.S. dollars (foreign currencies) and much of the income received by the Fund will be in foreign currencies, but the Underlying Index and the Fund’s NAV will be calculated in U.S. dollars. Furthermore, the Fund may convert cash in U.S. dollars to foreign currencies to purchase securities. Both the Fund’s ability to track the Underlying Index and Fund returns in general may be adversely impacted by changes in currency exchange rates, which can occur quickly and without warning.
The Fund uses various strategies to attempt to reduce the impact of changes in the value of a foreign currency against the U.S. dollar. These strategies may not be successful. Derivatives are investments whose value depends on (or is derived from) the value of an underlying instrument, such as a security, asset, reference rate or index. Derivatives may be difficult to sell, unwind or value. The use of a derivative may be more volatile than the underlying direct investment. The Fund invests in the securities of non-U.S. issuers, which securities involve risks beyond those associated with investments in U.S. securities. The performance of the Underlying Index and the Fund may deviate from that of the markets the Underlying Index seeks to track due to changes that are reflected in the sector more quickly than the quarterly rebalancing process can track. Securities in the Underlying Index or in the Fund’s portfolio may also underperform in comparison to the general securities markets. The strategy used by the Advisor to match the performance of the Underlying Index may fail to produce the intended results. Mid capitalization companies are generally less established, and their stocks may be more volatile and less liquid than the securities of larger companies.
The Wall Street Journal Dollar Index is an index (or measure) of the value of the U.S. dollar relative to 16 foreign currencies. The index is weighted using data provided by the Bank for International Settlements (BIS) on total foreign exchange (FX) trading volume. The index rises when the U.S. dollar gains value against the other currencies, and falls when the U.S. dollar loses value against the currencies.
Hedged: A hedge is an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security.
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