For investors, any diversification benefit from U.S.-dollar exposure may require careful consideration in the coming quarters.
“Between valuation and … fundamental factors, we think the dollar could be a weaker currency,” said Richard Lawrence, senior vice-president of global fixed income at Brandywine Global Investment Management in Philadelphia, Pa., in a March 23 interview.
Last year, Lawrence was constructive on underweighting the dollar, “which paid off, other than a very tough first quarter when we had that dollar liquidity squeeze in March of 2020,” he said. The Federal Reserve subsequently came to the rescue with supportive monetary policy.
With the dollar “in a nice descent” through the rest of 2020, “it really made sense to own a diversified basket of both developed and emerging market currencies, which is what we did,” Lawrence said.
The dollar continues to be overvalued by about 15% according to his firm’s purchasing power parity model, he said, and government support is one of the factors poised to weaken the dollar.
The U.S. government’s Covid relief packages amount to 25% of GDP, and the U.S. budget deficit and current account deficit combined are about 19% of GDP, Lawrence said — a figure that’s “never been higher” and will put downward pressure on the dollar.
He also noted that the U.S. economy doesn’t receive the full benefit of fiscal stimulus. Despite U.S. consumers receiving stimulus cheques and spending again, imports are surging, he said.
“Those dollars are going overseas …, and the trade balance has widened” to its worst level in eight years, Lawrence said.
U.S. imports hit a record high in January of about US$260 billion. In February (the latest month for which data are available), the U.S. trade deficit grew to a record US$71.1 billion because of a decline in exports.
Further, the Biden administration is pushing for higher corporate taxes, and its policies will likely be less growth friendly and more focused on regulation, he said. (Biden’s US$2.3-trillion infrastructure plan was announced after Lawrence was interviewed.)
“All those factors could pressure the U.S. dollar lower,” he said.
Referencing strong U.S. economic growth in 2018, Lawrence considered that growth this year could accelerate and subsequently boost the dollar; however, there’s a key difference between then and now.
“While you could get a growth differential story between the U.S. and the rest of the world, we just don’t see that playing out with the same level of rate support that the dollar got in 2018,” he said.
“The Fed is very clearly on hold, and they’re not hiking rates every quarter [nor] tightening the balance sheet like they were in 2018.”
Jerome Powell, Federal Reserve chair, confirmed again earlier this week that he doesn’t expect to raise the Fed’s benchmark interest rate this year. Still, he said he expected strong growth in the second half of 2021.
Last week the International Monetary Fund forecast U.S. growth to be 6.4% this year — its fastest pace since 1984.
Considering the current environment and currencies, Lawrence said he was exposed to cyclical commodity currencies, including the loonie and Norwegian krone.
Within emerging markets (EM), he remains constructive, he said.
Globally, “not many asset classes still remain cheap,” he said. “But EM [foreign exchange] is one of those asset classes that actually does remain pretty discounted on a real effective exchange rate basis.”
EM currencies on his list have manufacturing- and commodities-based economies: the Mexican peso, Chilean peso, Polish zloty, Korean won, Colombian peso, Malaysian ringgit, Brazilian real, Russian ruble, Czech koruna, Hungarian forint and Indonesian rupiah.
“We think we’re pretty well diversified by region and also by type of economic exposure,” Lawrence said.
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