• Wealth Management

Worrying About a Weaker Dollar

A decline in the U.S. dollar against foreign currencies helped lift markets last year, but this year it’s more of a risk.

The impact of currency fluctuations on your portfolio can be one of the hardest influences for investors to grapple with. But it’s also one of the most important.

Last year’s unexpected weakness in the U.S. dollar was a critical component of the positive financial conditions that led to a revival in global growth, especially in emerging markets. A weak dollar helps U.S. exports by making them more affordable overseas. It also lifts commodity prices, which aids the emerging markets where many commodities are produced.

But while gradual dollar weakness can be a benefit, a more rapid decline can have a downside. Recently, thanks to U.S. tax cuts, which are likely to cause the deficit to increase, and comments from the Trump administration, the trade-weighted dollar index fell to a three-year low. That index, which you can look up using the ticker symbol DXY, is now down more than 13% since the end of last year, despite improving economic growth.

Below are four reasons this latest weakening in the dollar has me concerned:

  1. A weak dollar can stoke inflation. It makes imports more expensive for U.S. consumers and raises the price of commodities that are traded in dollars, such as oil. 
  2. Bond yields respond to inflation by moving higher (and bond prices move inversely to yields). That’s one reason the 10-year Treasury yield has risen past a three-year high of 2.66%. A jump in yields could be negative for stocks, which are valued in part based on their growth prospects compared to a risk-free Treasury rate. 
  3. U.S. financial assets are less attractive for foreign investors when the dollar weakens. That may have an impact on Treasuries, which are held in reserve by central banks around the world. Due to the tax cuts, the U.S. needs to issue more debt at the same time foreign buyers may find it less appealing. 
  4. Trade protectionism could add fuel to the fire. A weak dollar policy combined with more aggressive trade protectionism could spark too much growth too fast, leading to increased volatility and a potential boom-bust scenario for the U.S economy. Trade wars are usually inflationary and can ultimately squash growth in trade. 

Bottom Line: Deficit-financed tax cuts combined with recent jawboning by the Treasury Department and trade protection measures by the Trump administration have led to increased dollar weakness, which poses a risk to the health of U.S. markets. I advise investors to move assets into European and Japanese portfolios that don’t hedge out the impact of currency fluctuations (which many funds do). Adding more exposure to emerging markets also makes sense if the dollar continues to weaken.

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