USD and other currencies

[vand]

I thought it’s worth starting a thread to keep track of what is happening with currencies, especially the USD reserve currency.

Right now the USD is the weakest it has been in the last 3 years with DXY sitting around 91.2, having peaked at 104 a couple of year ago and touched 102 earlier this year.

It’s not a major investment theme right now because, well, the nature of trends is that nobody pays attention to them until they are more firmly entrenched and we start to see and feel the effects of the trend, but for the last 9 months the USD has done nothing but go down, and is now firmly in a bear market which will have implications for all major asset classes as it plays out.

Positioning yourself to navigate this trend successfully will go a long way to determining how much wealth you manage to build and preserve over the course of the next few years.

[cool7hand]

Frequent readers of this forum will know what I'm about to say. If this trend concerns you, you might consider Ray Dalio's All Seasons (aka All Weather) Portfolio. It's a low volatility portfolio including 7.5% in gold and 7.5% in commodities. These real assets will help offset the risk of a weak dollar.

[vand]

Frequent readers of this forum will know what I'm about to say. If this trend concerns you, you might consider Ray Dalio's All Seasons (aka All Weather) Portfolio. It's a low volatility portfolio including 7.5% in gold and 7.5% in commodities. These real assets will help offset the risk of a weak dollar.

Yes, hard assets will diversify you against weakness in the currency those assets are priced in. I think most people need some degree of exposure to them. I personally prefer more weighting to gold than commodities than what Dalio suggests, as gold behaves more like a money/currency than other commodities.

Many here will not remember the last USD bear market between 2002-2008, but there was a lot of worry back then when it hit it's nadir, and I remember classic contrarian headlines about supermodels not wanting to be paid in dollars:

https://www.marieclaire.co.uk/news/celebrity-news/gisele-bundchen-pay-me-in-euros-not-dollars-204566

Starting from a lower peak in 2020, there is no reason why the USD can't eventually undercut those previous lows from 2008-2011.

[hodedofome]

Currencies fluctuate. We're still above the trading range of the US Dollar as compared to where it was for most of the 90s. Nothing new to see here, moving on.

[PDXTabs]

Yes, every spare dollar that I get I turn into VT. No bonds, no cash.

[vand]

Here is why the price of the USD matters so much:

https://www.google.com/amp/s/moneyweek.com/currencies/602429/a-weakening-us-dollar-is-good-news-for-markets-but-will-it-continue%3famp

[habanero]

I live in TinyCountry(tm) and hence pretty much all my investments are abroad in different currencies - mostly USD and EUR, while my income and almost all my expenses are in domestic currency. As I generally travel a bit, we import a lot of stuff etc, I have obv some direct and indirect exposure to foreign currencies and will have so for the rest of my life. Most research suggests that in the very long run it does not matter if I own hedged or unhedget, but  currencies can fluctuate quite a bit and stay in another area for a decade or two.

I have settled for a roughly 50/50 mix of hedged and non-hedget. The fees on the hedged index funds are 0,05% higher, but that is a price I'm willing to pay to be partially hedged. When our currency got properly shit-canned in march/april I switched my purchases to hedged only for a short time, so I guess that constitutes a small amount of market timing/trading/whatever, but it did at least pay off.

[vand]

DXY sliced right through the 90's and now printing with a 80-something handle:

[ChpBstrd]

To clarify, the fear would be that the US would do to the dollar what the British did to the pound in the 20th century, as the world economy shifted to another currency as the world reserve, and as their own indebtedness increased. For example:

https://www.nationalarchives.gov.uk/cabinet-office-100/the-1967-devaluation-of-the-pound/

In recent years/decades, the value of the USD has fluctuated in a relatively narrow band compared to increases in currency issuance and indebtedness. Classical theories about the linkage between monetary/fiscal policy and the value of currencies have been, dare I say, proven wrong. Explanations for the failure of monetary theory include a lack of alternatives (hmmm, not really), lowered velocity due to wealth disparities (fairly convincing), growth in ex-US markets using the dollar (fairly convincing), and value placed on the low volatility of the USD even if its fundamentals are worse than some alternatives.

The bottom line question is what could prevent the US from being able to issue currency to fund its government? A rise in interest rates is about the only thing I can think of. So the proper hedge against such an outcome would be a contract with sufficient duration to span the length of a 1-2 year crisis, and a risk/reward profile that would involve paying a tiny amount upfront for an exponential payout, without the possibility of a big loss if wrong. A far-out-of-the-money put option on TLT might do the trick. A put expiring in 2 years at the $100 strike sells for about $2.10/share. At the $130 strike it is only $5.53 at the time of this post. In the event of a mild increase in interest rates, these bets would quadruple or more (and there'd be a financial crisis).
https://finance.yahoo.com/quote/TLT/options?p=TLT&date=1674172800

A slightly less direct play would be to buy OTM calls on TIP. Higher inflation expectations would, in theory, raise investors' expectations for the inflation adjustment inherent in TIPS, thereby making TIP more valuable. The $140 strike maturing in 2 years could be had for $0.60 / share.
https://finance.yahoo.com/quote/TIP/options?date=1674172800&p=TIP

There is a certain indirectness to both of these strategies, so I prefer just to apply a collar to my stock-heavy portfolio. This puts a floor on my losses, dramatically lowers portfolio volatility, and covers a lot more scenarios than just this one. For now, though, I'm running without hedges - a bet on the fed.

[bwall]

@ChpBstrd : Great analysis.

I enjoyed the link to the article about the devaluation of the pound. I think it was those events in the mid '60's that led to a British politician complain about the 'Gnomes of Zurich' who were *somehow* in greater control of British monetary policy than Britain itself was and therefore the real culprits.

As no one wanted to hold the pound in reserve as in the past, the only option was for the ex-reserve pounds to flow back to Britain and purchase goods and services. The result was inflation that could not be controlled by raising interest rates as the spending was uncoupled from current bank lending or an increase in the money supply--the money supply had already expanded in past decades but siphoned off as reserve pounds. Once all overseas pounds had been repatriated, inflation subsided again. 

This is at least how I understand those events.

[ChpBstrd]

The really simple way to hedge some currency risk would be to own currency ETFs as one's cash allocation.

https://etfdb.com/etfs/asset-class/currency/

[vand]

The getting-out-of-USD theme is gaining more and more traction as the DXY index gets ready to test the 2018 low just about the 88 level.

If/when that fails, it'll be new 6yr lows going back to late 2014, and probably not much support down until around ~84..

This is all providing a strong tailwind to anti-fiat plays: commodities, PMs & Cryptos all on a strong upswing.

[K-ice]

I live in TinyCountry(tm) and hence pretty much all my investments are abroad in different currencies - mostly USD and EUR.

Habanero, I am curious to know how you are investing directly in EUR. Any particular ETFs?

[habanero]

Habanero, I am curious to know how you are investing directly in EUR. Any particular ETFs?

No, I buy mutual funds. I own one fund that's FX hedged to local currency, and one that is not - both global equities as investment universe. So measured in my domestic currency the first has performance similar to the underlying index (MSCI World) while the second has index performance and FX exposure. So if my domestic currency weakens, the value of the unhedged goes up everything else being equal (and vice versa, obviously).
So the US part of the index is invested in USD, the European part in EUR/GBP/whatever, the Japanese part in JPY and so on.

If you buy any european fund that is not fx hedged, you basically have exposure to CAD/EUR in your case plus some other smaller crosses for the non-EUR-markets. It is pretty much the same as investing directly in EUR - when you buy it (or a similar ETF) the fund/ETF manager sells the CAD you invest to buy EUR in the market and uses those EUR to buy european equities or bonds or whatever. For an individual this is almost guaranteed to be cheaper as the fund manager can trade FX on much tighter spreads than a private person can in tiny amounts. If you withdraw the opposite happens, the fund manager sells a part of the fund, gets paid in EUR, exchange those to CAD and deposit in your account.

[MustacheAndaHalf]

habanero - Do those American and European mutual funds pay dividends in their respective currencies?  Do you have USD and Euros from December dividends?

A year ago I snagged the kindle e-book of Ray Dalio's "Big Debt Crises" for $1.  Some of it concerns countries dealing with inflation spirals.  I might be recalling wrong, but I think the depth of the crisis typically plays out over 2 years.  So if you're seeing a currency crisis, and can wait 2-3 years, there might be an opportunity worth researching.

[habanero]

habanero - Do those American and European mutual funds pay dividends in their respective currencies?  Do you have USD and Euros from December dividends?

Yes and no, the funds own the actual shares so they receive dividends in whatever currency the share paying out is listed in and it gets reinvested automatically. For tax reasons historically distributing funds have never really been a thing here and afaik there isn't a single one from the local providers where you actually receive the dividends. So apart from buying and selling there is no cashflow. Until very recently for individuals dividends where taxed as capital income the year you receive dividends, while dividends that got reinvested by the fund was not taxed. You only pay capital gains tax when actually selling and realizing a profit so it obv made no sense to have a fund distribute dividends as reinvestement means deferring taxes for a very long time and adding to the compounding. Now the tax rules have changed, but the funds haven't. I could probably buy a distributing fund from an international provider, but I haven't looked into it as it is of no interest for me personally. So the funds basically track the total return version of the index.

So for both funds I own the value is in domestic currency, when I buy I use domestic currency and if I were to sell I wold receive domestic currency. But as the actual holdings in the funds are international (they track the MSCI World Index) I have FX exsposure in the non-hedged fund.

So for example's sake, say the S&P 500 is unchanged from Jan 1st til 31 dec. 2% dividends where paid out by the index constituents. Assume 0 fees.

1 Jan I invest 100 in my domestic currency in an S&P 500 tracking fund from a local provider, 8 units of domestic currency equals 1 USD at the start of the year, but 9 at the end of the year ( so weaker vs USD)

At the end of the year the hedged fund would be worth 102 in domestic currency (unch index but 2% dividends during the year).
At the end of the year the unhedged fund would be worth 102 * 9 / 8 = 114.75, reflecting the weakening of my domestic currency vs USD so measured in domestic currency my USD-denominated investments are worth more.

In reality it's a bit different as the hedged version has a 0.05% higher management fee, but you get the drift.

As a citizen of a tiny country with a tiny currency you can argue for various degrees of FX hedging as your expenses are local but a lot of stuff is imported, you travel abroad and so on. I'd say that 0% is probably wrong and so is 100%, I have settled for  roughly 50/50 with some opportunistic view on which one I buy at any given time. This march/april our local currency got abseloutly hammered, by so much that the non-hedged fund barely fell in value despite world markets tanking hard. At that time, almost all my buying was in the hedged version as I assumed the currency would recover from its very wild ride, which it also did to a large extent. The same happened in 2008/2009 for that matter. As long as I aim to keep the split at around 50/50 I will in practice buy the "cheaper" one most of the time - I don't rebalance by selling one and buying the other so the 50/50 is a rather soft target in that respect.

[habanero]

Here is a neat figure showing the effect over time. This is for Norway's petroleum fund. It started out owning only govvies, then gradually more equities and less bonds and now also some commercial real estate around the world (a small part of the total). Current equity allocation is just short of 70% in global equities, global bonds just under 30% and a couple of per cent in real estate.  Historically a fair bit overweight Euope vs US (in hindsight not brilliant, but it's a political decision).

The fund is not FX hedged as they want to preserve the international purchasing power, but the value is in domestic currency (NOK).

The dark blue bar is inflow (aka "savings"), the light blue is market returns measured in interntional currencies and the grey bar is FX effect. The numbers are in billion NOK btw, divide by ~8.4 at mom for the USD equivalent. Figure ends after Q2 2020 btw. Of the toal returns of ~7000 bn NOK about 2000bn is due to FX (weakening of NOK, the reporting currency).

[MustacheAndaHalf]

Ah, that's more convenient - even the unhedged dividends are converted back to local currency when withdrawn.  I imagine people in Europe actually have the reverse problem: the U.S. dollar has fallen more than the Euro, so unhedged diversification gets eroded.

ITOT (U.S.) gained +20.74% past 1 year
IXUS (int'l) gained +11.83% past 1 year
Euro was worth $1.12 USD a year ago, and is now $1.21 (-8%)

Currency impacts the entire holding, so the 120.74% of ITOT gets divided by 1.08 to become 111.76%, or a net gain of 11.76% for someone buying in Euros.

[vand]

We had a technical bounce back to 93 on the DXY index, but the subsequent selloff has been vicious.
Within a whisker of the January lows now. If that gets taken out then it looks like the next leg down to 80-82 area.  Expect commodities to continue Soaring if that plays out.

[ChpBstrd]

We had a technical bounce back to 93 on the DXY index, but the subsequent selloff has been vicious.
Within a whisker of the January lows now. If that gets taken out then it looks like the next leg down to 80-82 area.  Expect commodities to continue Soaring if that plays out.

Could this reflect an expectation that interest rates will rise faster/earlier in other currencies than they will in USD? The recent disappointing jobs numbers certainly mitigated some rate hike fears, but US inflation is already outpacing the EU.

[vand]

We had a technical bounce back to 93 on the DXY index, but the subsequent selloff has been vicious.
Within a whisker of the January lows now. If that gets taken out then it looks like the next leg down to 80-82 area.  Expect commodities to continue Soaring if that plays out.

Could this reflect an expectation that interest rates will rise faster/earlier in other currencies than they will in USD? The recent disappointing jobs numbers certainly mitigated some rate hike fears, but US inflation is already outpacing the EU.

IMO the market is just pricing in the new reality for the US economy for the foreseeable - there will be an acceleration in monetary printing throughout the next few years to fund whatever Uncle Biden wants to fund and the orthodoxy is now to inject huge amount of liquidity into the system to expunge any downturn.  The US deficits will grow and the debt will continue to climb at an alarming rate.  Ultimately no entity - whether it be individual, institution, or nation - can afford to live beyond its means and issue endless IOUs in order to fund the gap between what it produces and what it spends.

I mean, sure, everyone is using the same playbook so its a case of race to the bottom, but I guess the Fed is not even trying to hide that its remit is to support the political will to hugely increase public spending at this time.