Why Experts Says It May Be “King Dollar” No More

Why Experts Says It May Be “King Dollar” No More

Posted On May 8, 2023 10:09 am

Last week, we discussed the notion of allocating a small portion of your portfolio into gold via the SPDR Gold ETF (GLD) with one of the reasons being the belief the U.S. Dollar might be in a cyclical downturn.

This week, I want to use Magnifi to research funds that provide direct exposure to the dollar, whether it be for bullish or bearish positioning.

Since its peak in September, the greenback has fallen about 8.3% from a peak based WSJ Dollar Index, and is experiencing its worst start to the year since 2018.

Investors are betting the U.S. currency has further to fall as the Federal Reserve nears the end of its most aggressive program of interest-rate increases since the 1980s. Also weighing on the dollar: concerns over the banking system, a potential U.S. debt default, and expectations, shared by many economists, that the U.S. will slip into recession in the coming months.

While U.S. consumers (and politicians) like to brag about “King Dollar” for both emotional and economic reasons – a strong dollar provides consumers more purchasing power by making imported goods less expensive – it is not necessarily helpful to multinational corporations as it makes their exports more expensive.

Remember, of the companies comprising the S&P 500 Index, some 65% of revenues come from overseas. A strong dollar can not only slow sales, but also squeezes margins as sales in relatively weaker currencies get exchanged back into dollars.

In that sense, a weaker dollar is typically good news for the global economy. It lowers the cost of servicing or repaying dollar debt for foreign companies and governments, boosts the value of overseas earnings by U.S. multinationals, and can bolster global trade because goods priced in dollars become more affordable to international buyers.

“It’s a release valve for global growth,” said Mr. Nick Wall, head of Global Currencies at JP Morgan (JPM). “60% of global liabilities are denominated in dollars; a lot of those are in emerging markets, and emerging markets are responsible for maybe two-thirds of global growth in the last decade.”

This speaks to a political issue we touched upon in discussing gold; namely many countries, namely Russia and China, would love to see the dollar displaced as the global reserve currency.

The US dollar’s global supremacy is reportedly eroding at an exponential rate, with countries backing away after witnessing how America used USD to impose sanctions against Russia.

In a new Bloomberg report, Stephen Jen and Joana Freire of asset management firm Eurizon SLJ Capital reveal that in 2022, the US dollar’s market share in global reserves plunged 10 times its average speed of the past 20 years.

Considering the fluctuations in exchange rates, the dollar lost about 11% of its market share since 2016 and twice that amount since 2008.

China, Russia, and Saudi Arabia, have recently been closing trade deals using the yuan rather than the dollar. Reuters recently reported the Chinese Yuan became the most widely used currency for cross-border transactions in China in March 2023, overtaking the U.S. Dollar for the first time. Saudi Arabia also is talking with Beijing to sell crude oil to China for yuan. Even Elon Musk is chiming in on the dollar’s demise, tweeting, “If you weaponize currency enough times, other countries will stop using it.”

It’s not just nations perceived to be hostile to the U.S. looking to unshackle themselves from the Dollar’s yoke; Jen and Freire noted that countries located in Asia, Latin America, Africa, the Caribbean, and the Pacific Islands – collectively known as the Global South – are shedding their dollar reserves.

As are nations that comprise the Eurozone. “The dollar-exceptionalism story is weaker not just from the rates perspective, where rates may have peaked, inflation may have peaked well ahead of the eurozone and the rest of the world, but also from a growth perspective,” said Federico Cesarini, head of developed-market foreign exchange at Amundi Institute.

Mr. Cesarini said rising European interest rates were a “regime shift” for the currency market that could lead to a multiyear dollar downturn. Investors have shunned European bonds since the ECB introduced negative rates in 2014. Now, they are coming home.

According to Cesarini, the dollar now accounts for 58% of global reserves, drastically down from 73% over two decades ago when the currency was considered as the “indisputable hegemonic reserve. This is really just the beginning,” he said. “I strongly believe a lot of capital from eurozone guys will have to be repatriated back.”

Even legendary investor Stanely Druckenmiller, who may know more about currencies and macro trends than Musk, was recently quoted as saying, “The one area I feel reasonably comfortable in is, I’m short the U.S. dollar.” Druckenmiller explains, “Currency trends tend to run at least two or three years. We had a long one here, over $10 trillion came into the U.S. dollar during the previous decade.”

“The U.S. is coming out of a period of extraordinary outperformance. Other countries are starting to catch up,” added Nick Wall, head of global foreign-exchange strategy at J.P. Morgan Asset Management.

All that said, history suggests dollar weakness could prove short-lived. In the Fed’s past four rate cycles, the dollar typically weakened or traded flat for three to four months after the final rate increase, before eventually resuming its strengthening, JPMorgan strategists found.

“When you look at the long-term trends, I continue to be relatively favorable on the dollar,” said Joseph Lewis, head of corporate hedging at Jefferies. “Big picture, the U.S. still has this dynamic environment that is drawing capital flows.”

One popular fund that tracks the U.S.Dollar is the Invesco USD FUND ETF (UUP), which uses futures contracts of a basket of currencies to track the Deutsche Bank Dollar Index. The expense ratio is a bit rich at 0.75% but UUP does offer a dividend yield of 0.89% on interest earned from short term notes or money market funds.

For those that don’t want to make a bet on the direction of the dollar, but simply want to remove currency risk from their portfolio, the iShares Currency Hedged MSCI EAFE ETF (HEFA) offers a solution. HEFA invests in large and mid-cap stocks from developed markets outside of North America while hedging against currency fluctuations.

WisdomTree Europe Hedged Equity Fund (HEDJ) is another ETF which…

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About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.