Take Your Currency Bets Off The Table

The U.S. dollar is one of the most hotly debated questions right now. It’s a macroeconomic factor that impacts returns of many asset classes, from emerging markets to U.S. large-cap multinationals.

The standard narrative goes like this: the dollar cannot continue its gains from 2018 because the Federal Reserve (Fed) is done hiking interest rates. We’ve had a maximum divergence in rate differentials, with U.S. investors being paid over 3% per year in carry just to neutralize FX from their equity investments by hedging currencies.

Perhaps without realizing it, U.S. investors are consistently biased toward a weak-dollar worldview, as they traditionally layer weak-dollar bets on top of their international equities. Perhaps some just want to believe the dollar is going to decline forever.

I’m more cautious about predicting a perpetual decline in the dollar. I believe most people should have far less conviction in their inherent currency directional bias in unhedged portfolios.

To me, being truly FX-neutral implies taking no currency bet at all—that is, being fully currency-hedged.

The timing decision involved in switching to a more hedged baseline is always what inspires these conversations with clients.

Most fear they’ll get the timing wrong in going currency-neutral, concerned that if now is the time the dollar is going to decline again, they’ll miss out on the gains.

Our dynamic directional models point to a stronger dollar environment, based on the high carry and momentum of the dollar. We admit the dollar is not cheap on a valuation and purchasing-power parity basis, but other macroeconomic factors point toward subsequent dollar strength. Perhaps now is a good time for a fresh look.

One piece of supporting research for a stronger dollar comes from Danielle Di Martino Booth, an economist I met two years ago at Camp Kotok at Leen’s Lodge in Maine.

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