Market Views: How Asian investors should assess the high US dollar
The US dollar (USD) rose for a fourth straight session on Monday (October 10), as investors expect inflation data later this week to show that price pressures remain elevated in the world's largest economy, driving belief that the Federal Reserve's aggressive monetary policy will continue until next year.
The USD index was up 0.3% at 113.10 on Monday after a short dip to 110 last week. It has since continued its ascent towards last month's 20-year high of 114.78. US data due on Thursday is forecasted to show that headline inflation came in at a hot 8.1% year-on-year rate in September, but down from 8.3% in August. Core inflation is expected to have risen to 6.5% from 6.3% previously.
Chicago Fed President Charles Evans on Monday said inflation is much more persistent than the US central bank initially thought. But he noted that the Fed may still be able to lower inflation without a sharp rise in unemployment and without pushing the economy into a recession.
Regarding Asia, the USD climbed to a fresh 24-year peak versus the yen on Wednesday (October 12), holding above levels that prompted intervention by Japanese officials last month. In the wake of the U.S. PPI data, the greenback rose as high as 146.98 yen, its strongest since August 1998.
Against this backdrop, AsianInvestor asked asset managers how Asian investors with allocation plans to the US should react to the historically strong USD, and what new opportunities the strong dollar provides in the US for Asian investors.
The following contributions have been edited for clarity and brevity.
Mabrouk Chetouane, head of global market strategy solutions, international
Natixis Investment Managers
The relative firmer footing of the US economy against the rest of the world is leaving the Federal Reserve more unconstrained with regards to its policy tightening to fight inflation. This has prompted a relentless rise of the greenback and triggered negative loops across global markets. Signs that US inflation, especially core inflation, is peaking and heading to more manageable levels are therefore needed for the Fed to declare victory.
Given the number of rate hikes already delivered and the ones that being priced in by markets, we believe it is fair to say that we are in the later innings of this dollar rally. While it may still have a bit more room to run in the near term, as tighter monetary conditions keep feeding through into the real economy, it is already appropriate to start reducing long US dollar exposures.
In the short term, non-USD investors may still benefit from their long US dollar as we cannot exclude it is likely to have another leg up. Looming recessionary concerns coupled with the greenback’s ultimate safe haven status should support our view. Therefore, the yields currently offered by US long-dated sovereign bonds on an unhedged basis do look like an attractive opportunity in the short term.
Nevertheless and in the medium term, we do expect the Fed starting to turn one eye away from fighting inflation and stop being on the front foot when it comes to its tightening process. The end of support from the Fed's monetary policy should cause a repricing of the U.S. currency, which will logically depreciate. This repricing of the dollar can be achieved rapidly as the volatility of the foreign exchange market is elevated negating then the benefit of being exposed to the US financial market. The investment horizon is therefore the key variable that investors have to include in their investment decision-making process especially when they are exposed to the US dollar.
Chang Hwan Sung, portfolio manager
Invesco Investment Solutions
Despite the expensive valuation of the US dollar, we maintain an overweight position in the US dollar, as global growth is underperforming consensus and monetary policy continues to tighten. Historically, this combination of cyclical forces has overcome demanding valuations in the greenback.
In this environment within equities, we are underweight value, small and mid-cap equities, favouring defensive factors like quality, low volatility, and momentum. This results in defensive sector exposures with higher duration characteristics and lower operating leverage, such as information technology, communication services, and health care.
We expect these defensive characteristics to outperform in an environment of below-trend and slowing growth, strong US dollar, and peaking bond yields. From a regional perspective, we maintain a moderate underweight position in emerging markets relative to developed markets despite the modest improvements in China’s leading indicators. Historically, a global contraction regime with a strong US dollar and tightening financial conditions have provided headwinds to emerging markets, offsetting positive local momentum.
In fixed income, we are underweight risky credit as a contractionary regime has historically led to underperformance in high yield, bank loans, and emerging markets relative to higher quality debt with similar duration. We favour investment grade credit and duration in long-dated government bonds, expecting more flattening in the yield curve.
Ben Kirby, co-head of investments
Thornburg Investment Management
Many investors are hiding in the U.S. dollar, which we believe to be approximately 30% overvalued. The question all investors are asking is when the dollar will peak. I believe when the Fed stops their rate hike cycle, the dollar will reach its top commensurate with a market bottom.
Despite the pressure that the strong dollar puts on global markets, I don’t think it will cause China to crack. Even if the dollar continues to rally, China has a strong financial position and the latitude to weather the financial stresses that would otherwise cripple many other countries.
For investors in Asia and elsewhere, dividend-paying stocks are always a refuge. With negative returns in both stocks and bonds, and few other places to hide, we are focused on building portfolios of companies that make a profit, generate positive cash flow, and have the willingness and ability to pay a dividend. Investors should remember the power of dividends: they can boost total return while offering some protection in volatile, challenging markets.
Brian Nick, chief investment strategist
Nuveen
The US dollar has risen against just about every major currency in 2022 thanks to a combination of risk aversion, which tends to lead investors to prefer the most liquid, safe currency, and the aggressive tightening policy from the US central bank, the Federal Reserve. Changes in relative real interest rates are the primary drivers of short-term currency movements, and real rates have risen by more in the US than in other countries. Asian investors should be wary of unhedged exposure to the US dollar over the medium term (1 to 3 years) with its level likely to decline somewhat as other countries tighten more and the Fed backs off at some point.
The strong dollar is also hurting the earnings outlook for internationally-focused US companies, but should help stocks of companies in other areas of the world, including Asian but also Europe, that sell goods and services to US customers. Lastly, as the strong dollar has been correlated with a significant rise in interest rates, US bonds – including corporates and municipals – may look attractive to Asian investors seeking yield.
Ray Sharma-Ong, investment director of multi-asset
abrdn
Asian investors can position for USD strength through outright and relative-value opportunities via: (a) US quality companies, (b) USD and USD hedged investment grade bonds, (c) currencies and equities of service-driven economies.
a. The quality of companies will matter a lot more to investors with tighter policy driving USD strength. Higher restrictive rates and slowing demand result in demand destruction, causing corporate earnings growth to decline. We see relative-value opportunities for companies in the US that have strong fundamentals, strong cashflows, and quality earnings, and we expect these US quality companies to outperform the broad US market.
b. We see USD and USD hedged Investment grade (IG) bonds outperforming high yield bonds on a relative basis, as the quality of debt and issuer balance sheet come into focus as funding costs rise. USD IG bonds are attractive due to elevated bond yields, better issuer quality, and providing Asia investors with USD exposure.
USD hedged IG bonds provide sizable currency carry pick-up for Asian investors given the interest rate differential between US and most of Asia. Carry pickup from Long USD, Short CNY, TWD, KRW, JPY, through currency forwards, are now very attractive, and come with an annualized carry pickup ranging between +2% to +5%.
c. We see relative outperformance opportunities in service-driven economies vs goods export-dependent economies. Slump in demand for goods is expected as economic growth contracts, and goods export dependent countries are vulnerable through portfolio outflows and decline in trade volumes. We expect both the equities and currencies of service-led economies to outperform goods export-dependent ones. In addition to the USD outperforming the currencies of goods export-dependent economies, we also see opportunities for the currencies and equities of service driven Asean countries (such as Singapore and Thailand) outperforming that of Taiwan and Korea.
Tai Hui, chief market strategist, Asia Pacific
JP Morgan Asset Management
Instead of simply thinking about the direct foreign exchange impact on investment return from a strong U.S. dollar (USD), it is also worth considering the triggers for USD appreciation. We believe this is driven by a combination of a hawkish Federal Reserve and investors’ concerns for weaker global economic growth. We do agree that the aggressive policy rate increase by the Fed is adding more downside risk to the global economy, which would prompt investors to take a more defensive position in the near term. U.S. government bonds and high quality corporate debt are a good place to start.
In the longer term, once the Fed is done with policy tightening and economic data start to stabilise, we should expect to see the USD weakens gradually. This typically benefits risk assets, especially in Asia and emerging markets. Many Asian currencies and their equity markets are attractively valued, but they need a catalyst for a sustained rebound. The peak in bond yields and an economic upturn, which could take place in 2023, should be the spark that provides investors the opportunity to rebuild their position in Asian equities.
Dwyfor Evans, head of Asia Pacific macro strategy
State Street Global Markets
US assets continue to look attractive on a relative basis. The strength of the USD has hedging implications for foreign investors, namely that hedging costs are high. The upshot is that momentum in USD strength and its fundamental drivers – rates, flows – auger well for the USD over the near-term, such that Asian investors are likely better suited to gain exposure to US assets on an unhedged basis pending a shift in rates policy that we think is still some way off.
The relative growth story is important – a slowdown in the US is likely to be less severe than elsewhere across developed markets and this opens up opportunities in the equities space (unhedged). Likewise, US Treasuries look attractive in the context of headwinds to risk assets more generally and the strength of investor interest that we currently see in the US Treasuries market.
David Bianco, Americas CIO
DWS
Treasury yields, dollar and oil prices are intertwined. Rising yields usually strengthen the dollar and weaken oil prices. The dollar strength in this Fed hiking cycle is further boosted by gloomier than expected growth outlook in other regions – Europe, Japan, China and some other EM countries for many different reasons, such as the geopolitical risks in Europe and zero COVID policy in China.
The dollar surged on Fed hikes despite high US inflation, given raised real interest rates, and pressured the valuation of risk assets. FOMC guidance puts the Fed Funds rate at 4.25-4.5% at the end of the year, and suggests that the Fed is likely to maintain these rates or higher through 2023 even if a small recession hits. This 425bp of hiking in 9 months, since March, exceeds the average hiking cycle of 300bp over 15 months.
We doubt that the real Fed Funds rate or 10yr TIPS yields will stay over 1.5% over the next few years, but we believe the Fed and the bond market will sustain an at least 1% real risk-free rate for the next two years to lower inflation and help prevent it from rising again. This rate backdrop likely sustains dollar strength, but it could moderate a bit by late 2023.
The DWS CIO view forecasts EUR/USD of 1.05 in 12 months. We expect the dollar strength hits S&P EPS from 1Q22 levels by $1-$1.50 quarterly through 2023, which is a $4-6 hit to 2023 annual EPS. We recently cut our 2022E and 2023E S&P EPS by $5 and $15 respectively, from $227 & $235 to $222 & $220, and lowered our S&P 500 fair PE estimate from 18.5 to 17.5. Our 2022 and 2023 end-year targets are now 3800 and 4000.
Michael Kelly, global head of multi-asset
PineBridge Investments
It has been said that currencies are all about differentials and relativity. At present, the US is the most resilient economy showing the most favourable growth, resilience, thus the fastest interest rate rises, and balance sheet shrinkage. These are all contributing to the strengthening of the USD which has begun to be described as a big wrecking ball since the strong dollar (and in the midst of an overheating world), is bringing benign disinflationary forces to US shores while stirring inflation elsewhere. As a result, not only the USD but also US-based assets have strong forces acting as a tailwind for them while other markets are experiencing headwinds.
We believe this will pass. Despite the tailwinds and history of currency overshoots, the USD is now overvalued making it hard for it to rise too much more. If history is any guide, the USD will top out in between the Fed's last hike and first cut, which we think will take place sometime in the Spring/Summer of 2023. Until then, we are taking active steps to implement currency overlays across our mix of asset class investments to offset the rising USD. With our dynamic approach, we will be ready to adjust these overlays as we approach the first hike.
Ben Bennett, head of investment strategy and research
Legal & General Investment Management.
The strong US dollar is a symptom of tight US monetary policy and the global risk off environment. It’s telling you to reduce risk, hide in short-dated US bonds and, above all, cut your US dollar borrowing. It’s these conditions when people who borrowed dollars to buy illiquid assets can be really squeezed, leading to significant market volatility.
But it is unlikely to last forever. Once the Fed is comfortable that the inflation genie is back in the bottle, they can pivot to a more accommodative stance which should coincide with falling yields and a weaker dollar. At that time, investors should be able to pick up some opportunities. Already, the Bloomberg US high yield corporate bond market is yielding over 9%, while the investment grade equivalent is close to 6%. Equity PE multiples have also collapsed, implying interesting investment yields.
However, I’d be surprised if we see this pivot in 2022. A move in the first half of 2023 seems more likely to me as the global recession weighs on US growth. And at that point, valuations could be even more attractive. The key is to maintain liquidity and be patient.
Sven Schubert, senior investment strategist
Vontobel
A few factors are likely to support the Dollar further in 2022. Firstly, core inflation might be more persistent than investors are hoping for. Last week’s US payroll data has shown the negative market reaction to solid US labor market numbers. Fiscal policy is also becoming looser in a number of countries, including the US. Both should convince the Fed to deliver on the rate front this year. Secondly, the energy crisis led to a relative purchasing power gain of the US vs. commodity importing countries in Asia as the US economy is less exposed to higher international commodity prices. The recent Opec cut, further acts of sabotage on energy infrastructure and a cold winter could even lead to higher pricing over the next few months leading to further Dollar support.
The attractiveness of US assets has clearly increased in 2022 and we are slowly approaching attractive buying opportunities. But we are not there yet. 2023 earnings expectations have still room for a downgrade. Despite the weak equity market performance year-to-date, we have not yet observed market capitulation, which has been necessary in the past to end bear markets. Historical bear markets suggest US equities may correct another 10% before trending sustainably higher and our modelling indicates that economic momentum is deteriorating. While we see value in longer-term investments in bonds and equities, the timing seems still not right for tactical positions. The Dollar on the other hand has still more room to run.
Gregoire Durel, senior investment specialist, Asia
Amundi
Over the last 12 months, the US dollar has risen an impressive 19.0% against a basket of international currencies, and propelled a Fed on the battle path to lower inflation. On the short-term, we believe the USD strong momentum has room to continue, driven by a combination of macroeconomics (uncertainty about the global growth outlook and especially a likely recession in G10 economies), politics (geo-political risk in Europe/Russia) and financials (continued Fed tightening leading to rising US interest rate differentials versus Euro, Jaoan, UK and China) factors.
On the long-term, the seeds for a weaker USD are growing, with peak nearing for Fed tightening cycle (Q2 2023), rising twin deficits and signs that easier monetary policy across emerging markets alongside easier fiscal policy will help stimulate domestic growth later in 2023 and lead to a divergence in US vs EM growth. Also, we keep in mind that, the recent move, while material, is not out scope of historical standard and we have seen similar strengthening in 2015 or 2009.
For Asian investors, amid the recent bout of volatility, owning assets in USD still presents a compelling investment case, with the benefit of the USD having historically behaved as a safe haven in troubled times. Nonetheless, once macroeconomic uncertainties recede and the Fed’s tightening cycle ends, Asian investor may want to start hedging their USD exposure.