We believe the main pillars of US dollar strength last year—aggressive tightening by the Federal Reserve and a resilient US economy—are unlikely to support the currency going forward. The Fed is coming closer to the end of its tightening cycle, and markets are seeing scope for rate cuts later this year. Meanwhile, the Fed stressed that tight credit conditions are slowing down the economy in its March meeting, with its 25-basis-points rate hike adding to this pressure.
So, with the inflection point in monetary policy we have been looking for in our 2023 Year Ahead publication approaching, we recommend several main strategies to deal with a declining dollar:
Non-USD investors should strengthen home bias with a currency hedge or asset shift. This is a natural move for non-USD based investors, when they have accumulated large savings in the dollar and face the risk of depreciation. Many investors have expanded their USD holdings in recent years, as US equities and fixed income offered interesting opportunities. More recently, we have already seen a fair amount of repatriation into the euro, Swiss franc, and other G10 currencies. We think this trend will continue and further weigh on the US dollar.
Increase exposure to select G10 currencies. We have the Australian dollar as our most preferred currency, which we expect to benefit from China's recovery. We also see upside potential for the Japanese yen and the Swiss franc, as both countries benefit from low inflation. The Swiss National Bank has shown a convincing commitment to fighting inflationary pressures, while Japan is expected to move away from ultra-expansive monetary policy. Europe will also likely be forced to tighten further. In our view, the euro is not likely to move very fast anytime soon. Europe needs a strong improvement in export growth for the currency to really shine, and this is difficult to achieve with the geopolitical tension in Eastern Europe. The pound, meanwhile, suffers from an unfavorable growth and inflation mix.
Consider adding gold to your portfolio. The gold price measured in USD tends to rise when the dollar falls on a trade-weighted basis and when US interest rates are declining. Fed easing expected for later this year or early next year should accelerate that process even further. UBS CIO forecasts the gold price to rise to USD 2,100 per ounce within the next 24 months. The higher price would more or less compensate for any foregone interest rate payments and add diversification.
Be long the emerging market carry basket. UBS CIO issued a thematic recommendation for a basket of select emerging markets currencies. At the moment, we like to be long the Indonesian rupiah, Indian rupee, Mexican peso, South African rand, and Czech koruna against the USD, euro, and Taiwan dollar. With this basket, the client is likely to benefit from the improved outlook for emerging markets and high nominal interest rate carry.
Main contributors - Mark Haefele, Thomas Flury, Patricia Lui, Christopher Swann, Jon Gordon
Content is a product of the Chief Investment Office (CIO).
Original report - Managing a declining US dollar, 30 March 2023.
