The U.S. Federal Reserve can affect the dollar exchange rate, and U.S. equity markets, through their monetary policy decisions. For example, in 2018, the Fed began to signal an increase in their overnight rate, making U.S. markets more attractive for yield-seeking investors. Consequently, the dollar appreciated by 4.40% relative to the ICE basket, and the S&P 500 outperformed international markets by 9.81%. Conversely, in the last few months, the Fed has become more dovish, reversing course and signaling rate cuts. As a consequence, the U.S. dollar has started to weaken. We believe the greenback will depreciate, particularly relative to emerging markets. And this may be the opportunity many investors have been waiting for to jump back into the international investing saddle.
Whether a strong or a weak dollar is better for the U.S. depends on where you stand. Importers love a strong dollar as their businesses become more profitable. Yet, exporters prefer a weak dollar that makes them more competitive in foreign markets. Overall, the dollar strength affects the U.S. current account; a strong dollar increases the trade balance deficit, which currently stands at a historical high of $12 trillion. Over the last decade, the U.S. has been of the view that a strong dollar is better for the country, regardless of the trade deficit. That policy is in direct contrast to that of the 1980’s where a depreciating dollar was actively pursued to reactivate the economy[1]. The current administration believes the dollar is too strong and that this negatively affects the U.S. economy. The U.S. Treasury is mandated to oversee the dollar exchange rates. Therefore, making this a policy decision. Nevertheless, this could be a costly decision leading up to an election year.
By lowering their overnight rate, the Fed may solve the strong dollar situation for the current administration, albeit without being mandated or trying to do so. This may also create opportunities for U.S. investors. Currently, the average U.S. investor is underweight international equities. A depreciating dollar will make international equities more attractive relative to U.S. equities. However, we argue that investors must be selective. The European Central Bank, for example, has also taken a dovish stand which will put pressure on the Euro and make investments in the region less attractive in U.S. dollar terms. Overall, we believe this is a good time for U.S. investors to revisit their portfolio allocations and selectively increase international equities, which as a bonus, can provide valuable diversification benefits.
The Innealta Dynamic portfolios utilize our proprietary three-lenses approach (i.e., fundamental, macroeconomic, and behavioral) to evaluate the risk-reward potential across different asset classes, regions, and sectors. We believe that data-driven decisions have the potential to improve investment decision-making and ultimately outcomes. For more information about our market views, commentaries, and investment solutions, please contact us at consulting@innealtacapital.com
[1] The 1985 Plaza Accord resulted in approximately a 50% depreciation of the dollar relative to other major currencies
The S&P 500 Index is a diversified large cap U.S. index that holds companies across all eleven GICS sectors.
This material is for informational purposes and is intended to be used for educational and illustrative purposes only. It is not designed to cover every aspect of the relevant markets and is not intended to be used as a general guide to investing or as a source of any specific investment recommendation. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. This material does not constitute investment advice, nor is it a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. In preparing this material we have relied upon data supplied to us by third parties. The information has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made by Innealta Capital, LLC as to its accuracy, completeness or correctness. Innealta Capital, LLC does not guarantee that the information supplied is accurate, complete, or timely, or make any warranties with regard to the results obtained from its use. Innealta Capital, LLC has no obligations to update any such information.
Currency War Banknotes from Different Countries on a Chess Board by Jay Yuan/Shutterstock.com
246-INN-06/28/2019
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