Thoughts on U.S. Dollar Positioning
Investors entered the year anticipating a stronger U.S. dollar only to be disappointed as economic data diminished the perception of a U.S.-led global recovery. The yen showed some resiliency, and the euro strengthened on continued signs of recovery. In our view, the Fed’s statements reinforce the perception that policy makers are much closer to raising rates than the European Central Bank and the Bank of Japan. Investors could look to re-establish their long dollar positions in anticipation of stronger data validating the Fed’s view of the economy.
Investors can achieve a broad-based exposure to a stronger dollar in a variety of ways, including hedging the currency risk of their international equity positions. Dollar-bull strategies—currency positions structured to directly benefit from an appreciating dollar against foreign currencies—can provide a unique diversifier as part of traditional portfolios. Historically, these positions tend to exhibit negative correlations with traditional bond and equity investments. This is particularly valuable during rising rate environments, when valuations of these traditional assets can come under pressure. When considering such positions, an investor needs to look to broad-based exposures, which better offset the potential risks of unhedged exposures in international equity portfolios.
Ultimately, we believe that until positions can be further clarified or the future becomes clearer, investors may be wise to take Fed Chair Yellen’s comments at face value. Although we agree that the path of future U.S. interest rate policy is not on a preset course, reducing exposure to positions that will be most sensitive to increases in short-term interest rates or increasing positions that benefit from dollar strength could be a prudent course of action.
1Source: Bloomberg, as of 3/20/14.
2Source: WisdomTree, as of 12/31/13.
3Investors compensation also includes returns from short-term money market rates.
4As represented by the Barclays Rate Hedged U.S. Aggregate Bond Index, Zero Duration.
5As represented by the BofA Merrill Lynch 0-5 Year US High Yield Constrained Index, Zero Duration.
6Source: Bloomberg, as of 3/21/14.
Important Risks Related to this Article
Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. In addition, when interest rates fall, income may decline. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty.Investments focused in Russia or China are increasing the impact of events and developments associated with the region, which can adversely affect performance.