Many investors have diversified into international markets in search of greater opportunities but they will have to consider currency risks, especially with the Federal Reserve set to tighten its monetary policy. Nevertheless, ETFs can still capture global exposure and hedge foreign exchange risks with currency-hedged strategies.
“We believe a modestly higher USD ahead supports the case for favoring eurozone and Japanese equities,” BlackRock strategists, led by Richard Turnill, said in a research note. “Within currencies, we favor the USD to the euro and yen amid monetary policy divergence.”
The U.S. dollar is expected to strengthen against its foreign counterparts as the Fed normalizes interest rates ahead of its developed market peers and the U.S. economic growth exhibits upside potential.
However, U.S. dollar gains may be moderate since Fed rate hikes will likely come in slowly when compared to past cycles due to the relatively depressed U.S. inflation levels. According to BlackRock, U.S. core inflation is expected to return to just 2% in six months’ time, which falls in line with the Fed’s target levels.
A stronger U.S. dollar or a weaker Japanese yen and Eurozone euro currency will also be beneficial for the respective foreign economies as well.
“We see a stronger USD versus the euro and yen supporting equities in the eurozone and Japan, given these stock markets’ export-oriented nature,” according to BlackRock.
Related: Europe ETFs Can Catch Up to U.S. Rally
However, there is a risk of a sharp USD appreciation. For instance, U.S. tax reform or deficit financed tax cuts could trigger U.S. Treasury issuance and growth, which would lead to higher interest rates and a quicker appreciation of the greenback.
Consequently, ETF investors seeking international exposure should consider currency-hedged strategies that allow investors to capture upside potential in the global markets while hedging against potentially weakening international currencies or a stronger U.S. dollar.
For instance, the depreciating JPY has allowed currency-hedged Japan ETFs to outperform their non-hedged peers. For instance, the WisdomTree Japan Hedged Equity Fund (NYSEArca: DXJ), iShares Currency Hedged MSCI Japan ETF (NYSEArca: HEWJ) and Deutsche X-trackers MSCI Japan Hedged Equity ETF (NYSEArca: DBJP) have been go-to options to access Japanese equities markets while hedging against foreign exchange risks.
Meanwhile, investors who believed the euro currency could weaken after its recent rally and are bullish on the broader Eurozone turned to the Deutsche X-trackers MSCI EMU Hedged Equity ETF (NYSEArca: DBEZ), iShares Currency Hedged MSCI EMU ETF (NYSEArca: HEZU) and WisdomTree Europe Hedged Equity Fund (NYSEArca: HEDJ).
For more information on international currency hedged strategies, visit our currency hedged ETFs category.