Multi-managers are tipping the US dollar as one way to play the prospect of rising interest rates in the US next year.
The dollar has done very little in comparison to sterling year-to-date, down 0.54% at $1 to 61p between January and 6 December, having risen in the wake of the Federal Reserve’s announcement that it intends to taper quantitative easing (QE).
However, a number of leading investors suggest the tapering of QE, a continued economic recovery in the US and a perceived rise in interest rates could spell a strengthening dollar in 2014.
David Coombs, head of fund research at Rathbones, takes this view and plans to continue to overweight the US, even if equity valuations look expensive.
‘We feel the premium is justified and sustainable. We like the US domestic earners. If rates are rising in the US it means the consumer is confident and there is a strong US recovery. We like regional banks that can benefit from greater interest rate margins,’ he explained.
Linked to this, he is positive on the dollar going into 2014 and expects the currency will rise in relation to other major currencies on the back of tapering. He also holds Treasuries and inflation-linked bonds or ‘Tips’.
‘We are very bullish on the dollar and we are long versus other currencies,’ Coombs said.
Conversely, he is underweight emerging market currencies due to the possible negative impact that tapering could have, given the sharp sell-off that followed the Fed announcement in May. Nonetheless, commodity currencies could react differently, he noted.
‘On sterling we are fairly agnostic and suspect it will weaken against the dollar but might strengthen against the euro,’ he added.
EM entry point?
If the US dollar does strengthen next year and emerging market debt (EMD) and currencies sell off, Coombs said that if spreads on EMD reach 400 basis points it would represent an attractive entry point for his multi-asset funds. He currently has a zero allocation to EMD.
Bill McQuaker, head of multi-manager at Henderson Global Investors, expects the dollar to strengthen for multiple reasons, not least a normalisation in interest rates.
Other supporting factors include the US’s diminishing appetite for oil imports, which is dollar positive, alongside an ageing population’s increased spend on services rather than goods, which are often imported.
‘The other factor is that the US has got a significant manufacturing base and is now globally competitive,’ he said. ‘It does not need a weaker dollar from here.’
Although those that tipped a stronger dollar this year have largely been caught out, he points out that once the dollar does start to move it could move rapidly. The Australian dollar’s 15% decline against sterling this year is perhaps a testimony to this, he added.
Oliver Tucker, a fund of funds manager at Sarasin & Partners, says the case for a strengthening dollar makes sense in 2014, but he is awaiting further clarity once markets survive the debt ceiling and tapering.
‘Currency is an asset class that can often be very volatile and can trend for a long time. If you miss out on that trend or action, your total returns can be dramatically different,’ he said.
‘We have seen a period in time where the way that currencies have behaved has not been as dramatic as it has been in the past because of financial repression and quantitative easing policies.
‘Should currencies behave in a different fashion as policies start to diverge? It is entirely possible that we will see new trends emerge.’
Tucker, like Coombs, says emerging markets could come onto the radar if valuations continue to fall, highlighting the fact that yields on emerging market corporate bonds are approaching their 2009 highs.
‘It is a contrarian call. It is something we will do work on. Whether it is something we act on is a different thing,’ he said.
‘The key view in portfolios is to be short of the yen versus base currency, which in this case is sterling and all other views are off the table. We are hedging back to neutral with all opportunities.’
Further yen weakness?
McQuaker is also alert to a potential slowdown in the weakening of the yen next year, following its large scale devaluation as a result of QE.
While his portfolios were fully hedged against the yen for the first four to five months of the year, during the second half he shifted it to a 50% hedge. Nonetheless, he expects the trend will broadly be in favour of a weaker yen compared to the dollar and sterling.