How Investors Are Wrestling With the Greenback

The U.S. dollar’s drop is a big deal for international bond investors.

Illustration by Andrea Manzati

Illustration by Andrea Manzati

To hedge or not to hedge. Investors are weighing ways to adjust to the three-year lows hit by major dollar indexes amid a revival of economic growth overseas.

Currency swings can have a major impact on the value of institutional investors’ overseas holdings, but their responses to the dollar’s drop vary largely according to the assets they manage.

Currency direction influences the investment returns of foreign debt, so managers of foreign bond funds are more likely to adjust their foreign-exchange exposure to benefit from, or defend against, currency fluctuations. Many are shorting the dollar amid its decline.

Managers of foreign stock funds, by contrast, are less likely to manipulate their currency exposures, as currency moves have less impact on the returns of foreign stocks.

Money manager Amundi Pioneer Asset Management is one of the dollar sellers. “We started to position our portfolio to capitalize on the dollar’s depreciation early last year and began shorting it this January,” says Paresh Upadhyaya, director of currency strategy for the 1.4 trillion euro ($1.7 trillion) firm. “Now we’re continuing to build our position for the next one to two years,” he says, on expectation the dollar will keep weakening.

The greenback soared from 2013 to 2016, with the Bloomberg Dollar Spot Index gaining 27 percent from late October 2013 to late December 2016, as the Federal Reserve began tightening U.S. monetary policy and the European Central Bank and the Bank of Japan engaged in all-out easing.


“But now we’re moving from divergence to convergence on monetary policy,” Upadhyaya says. With economies rebounding overseas, the ECB already has begun to reverse its easing, and speculation abounds that the Bank of Japan will soon join it. “Meanwhile, the Fed is closer to the endgame” of its tightening, says Bob Browne, chief investment officer at Northern Trust.

The Bloomberg Dollar Spot Index plummeted 12 percent from December 23, 2016, through February 23 of this year.

After outperforming Europe consistently following the 2008 financial crisis, the tables are turning for the U.S. economy. Since the end of 2015, the euro zone’s year-on-year economic growth has exceeded U.S. growth every quarter, according to Eurostat and the U.S. Bureau of Economic Analysis, Upadhyaya says.

“The rest of the world is keeping up or growing faster than the U.S.,” he says. That will continue to feed the divergence of monetary policy between the Fed and other central banks. And that in turn will keep pushing the dollar down, he says.

Money managers say the dollar also will be weighed down by the massive U.S. current-account and budget deficits. The current-account gap totaled $100.6 billion in the third quarter, or 2.1 percent of gross domestic product.

The budget deficit registered $666 billion in the fiscal year ended September 30, or 3.5 percent of GDP. And it’s likely to explode in coming years because of the recent tax and spending bills passed by Congress.

Robert Tipp, head of global bonds for PGIM Fixed Income, notes the dollar’s trend over the last 50 to 60 years has been downward, with intermittent rebounds, as the U.S. has built up its debt. He expects the dollar to weaken for the next five to seven years.

“For investors with whom we have latitude, we have exposure to the euro bloc, select emerging markets, and other developed markets that have higher rates and see favorable growth prospects,” he says. “We’re likely to continue overweighting foreign currency.”

Tipp and other investors say the primary driver of foreign bond returns is currency movement. “Dealing with currency fluctuation is a big part of what I do,” says Ihab Salib, head of international fixed income at Federated Investors. Sometimes he’ll move assets from one currency to another, and sometimes he’ll hedge.

Like others, he’s bearish on the dollar, especially against emerging-market currencies. He’s long North African, Latin American, and eastern European currencies against the dollar. “We think that’s the best way to get alpha, rather than underweighting the dollar across the board.”

But the greenback’s oscillations have less impact on the returns of foreign stocks — returns that are mostly dictated by company performance. So international stock fund managers often see little need to implement costly hedging strategies.

“I don’t hedge, because it’s hard to do,” says Rajiv Jain, chief investment officer at GQG Partners, a global stock fund manager with $10 billion of assets. “It’s exceedingly difficult to forecast currencies. Hedging is expensive, and you can be horribly wrong in the next 12 to 16 months.” He and his colleagues are bottom-up investors, so they try to factor currency trends into their assessment of individual companies.

Hedging the currency exposure of foreign stocks also eliminates the diversification benefit of a foreign currency exposure, Jain notes. The dollar’s recent decline, of course, adds to the return U.S. investors are earning on foreign stocks. “Once you hedge, you eliminate the upside as well as the downside,” he says.