Why "America First" doesn't mean a stronger U.S. dollar
Henry Peabody, Diversified Fixed Income Portfolio Manager/Team Leader, and Kathleen Gaffney, Co-Director of Diversified Fixed Income
Boston - As the world's reserve currency, the direction of the U.S. dollar has a huge impact on investors as well as global markets and economies. Despite President Donald Trump's "America First" policies, our baseline view is that the dollar could weaken after a strong run.
Our view on the dollar is very important because it spills over into our thinking and expectations for many other markets and asset classes.
We believe that investors will be rewarded by having exposure to securities and sectors that will benefit from a decline in the value of the dollar over the long term. This includes local and hard currency non-U.S. debt, cyclicals and inflation-sensitive assets. Our reasoning for this, and basis for our preference away from traditional rate and credit risk, is based on four themes:
- Growth: Global growth is beginning to converge higher, allowing for less downward pressure on rates and use of currency as a lever. The focus is moving away from monetary policies (central banks) and toward fiscal policy (governments). The U.S. could see a pickup in growth, while both the EU and Japan have seen recent improvement in the tone of economic data. This will impact central banks and monetary policy.
- Valuation: The dollar is well into the upper end of its valuation range, exceeded only by the strength that prompted the 1985 Plaza Accord, the agreement between the G-5 nations to devalue the dollar.
- Sentiment: Continued dollar strength is the consensus view. Could the Federal Reserve hike rates at a slower rate than forecast? Yes. Could the European Central Bank (ECB) and Bank of Japan (BoJ) use U.S. fiscal expansion as a bleed valve and let rates drift higher? Of course.
- Politics and trade: Actions speak louder than words. Despite his rhetoric that would indicate otherwise, President Trump does not want a stronger U.S. dollar because of the detrimental effect it would have on global growth and the U.S. labor market.
The first three themes are certainly up for debate, are rather subjective, and could change. The last is the most powerful, the most difficult to quantify, and the most important.
How could the new administration impact the dollar? We think about Trump by focusing on his actions, incentives and long-term motives, rather than his latest tweet. Thinking about the byproducts of Trump policy is one way to handicap his likely actions. The President is likely aware of the risks associated with his protectionist policies. If the U.S. runs a narrower deficit, which would go hand in hand with a stronger dollar, global growth and liquidity would be impacted negatively. A persistent U.S. current account surplus would exaggerate a slowdown, and with geopolitical tensions already quite pronounced, this could increase risk.
Bottom line: So, what are investors to do? First, recognize that a consensus is one of the most challenging things for investors to fight against, but that doing so can be rewarding. Second, think about true underlying economics and be willing to take a long-term view. The dollar could improve and we could see a short squeeze, but this would be dangerous to global growth. Putting these together, we believe that political incentives are lined up to avoid a stronger dollar.
Investing involves risk including the risk of loss. Investments in foreign instruments or currencies can involve greater risk and volatility than U.S. investments because of adverse market, economic, political, regulatory, geopolitical, or other conditions.
