ALBERT HERTER

‘HOW TO PLAY THE DECLINING DOLLAR,’ in SmartMoney via fidelity.com.

In Uncategorized on November 11, 2009 at 12:51

The U.S. dollar is looking pretty downtrodden these days, and investors are split over whether the world’s reserve currency has reached a bottom.

 

Since March, the dollar has lost about 15% of its value against a basket of foreign currencies. (Gold, which tends to move in the opposite direction as the dollar, rose to a record $1,092 an ounce on Wednesday.) Safety-seeking investors tend to flock to the dollar in troubling times, and the currency generally underperforms during economic recoveries. Exacerbating this normal pattern are today’s super-low interest rates. Short-term rates of 0% to 0.25% have encouraged the dollar’s use in the carry trade, an investment where traders borrow in a low-yielding currency (in this case, the dollar) and invest the proceeds in a higher-yielding one. This in turn creates more downward pressure on the dollar, says Michael Woolfolk, senior currency strategist at Bank of New York Mellon. The Federal Reserve indicated Wednesday that it intends to keep short-term rates low for “an extended period” so the carry trade will likely continue for some time.

 

Woolfolk expects the dollar to continue its slide against the euro through the end of this year and possibly into 2010, but begin to strengthen as the Federal Reserve raises rates. Others say that the dollar could turn around quicker on good news like lower-than-expected inflation numbers (inflation causes prices to rise and lowers the purchasing power of each dollar). “Pessimism is almost at a peak,” says Rocky White, senior quantitative analyst for Schaeffer’s Investment Research. When it happens, the reversal in the dollar’s trajectory could be sharp, White notes.

 

Why should investors care about the dollar’s fate? A weak dollar makes U.S. exports cheaper abroad, helping export-driven businesses. But consumer spending, not exports, really drives economic growth in this country, so a weak dollar won’t necessarily aid our recovery, some analysts warn. By contrast, a strong dollar helps the U.S. maintain a larger deficit, Woolfolk says, which in turn helps stimulate growth and job creation. Foreign investors are more inclined to buy Treasury bonds when the dollar is strong. Over 60 percent of worlds’ central bank reserves are in dollars, Woolfolk says. And despite much rhetoric out of China, the largest foreign holder of Treasurys, suggesting that its appetite for U.S. debt might have its limits, the dollar isn’t going to lose its status as the world’s reserve currency any time soon, experts say.

 

Even so, the pros recommend that investors have some international exposure in their portfolios. Aaron Gurwitz, head of global investment strategy for Barclays Wealth, says investors should keep at least 20% of their portfolios in non-dollar assets and says the easiest way to do this is by buying foreign companies’ stocks. Foreign bond funds also look attractive these days, as countries like Australia have been quicker to raise interest rates than the U.S., pushing their bonds’ yields up.

 

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