Editor’s Note: In July, I sat down with Thomas Fischer to discuss some of his recommendations for investing in foreign currency, as well as his observations regarding global markets and foreign currency. Thomas is a long-time friend of ours and has been working in the financial sector since 1975. He currently serves as the Lead Consultant for ENR Asset Management, and for much of his career, he has traveled around the world, teaching investors about global investment strategies—including foreign currency diversification. In the article below, he offers a current glimpse into the foreign currency markets and how they have been affected by both the dollar’s strong performance this year and the ongoing trade war.
Rising Global Risk Premiums!
By Thomas Fischer
The macroeconomic differences between the U.S., Europe, and emerging markets have been the main driver for the push in the dollar in 2018. The U.S. has experienced robust growth and rising inflation (now at 2%), which has led the Fed to raise interest rates seven times in the current cycle (two so far in 2018). The trade-weighted dollar index has risen from 85 in February 2018 to 90.45 currently (end of August)—or a general strengthening of 6.5% in 2018. However, the rise of the greenback has been much bigger against “fragile” economies, such as South Africa (the rand is down 18% against the U.S. dollar) and Turkey (the lira is down a massive 78% against the U.S. dollar).
The risk of trade wars is still very real, as Donald Trump has been very aggressive in terms of trade policies in recent months. Trump has threatened many of the U.S. trading partners with imposing custom duties on imports. Mexico and the U.S. have just agreed to an overall trade agreement (details are still missing), but it looks like Trump will continue with his “maximum pressure” campaign against other trading partners until the congressional elections in November. Risk premiums have thus trended upward for a while, putting pressure on low valuation currencies such as the South African rand, the Turkish lira, the Norwegian krone, the Swedish krona, and the Polish złoty.
The euro has struggled all year against the U.S. dollar (down 3.5%) due to the trade tensions with the U.S. (Germany has a high exposure to trade) and interest rate differentials, as the European Central Bank has remained dovish.
I believe the U.S. dollar will remain strong for the remainder of 2018 as the two main drivers, (1) a strong U.S. economy and (2) risk of trade wars, will hold a firm hand under the U.S. dollar. The Gross Domestic Product (GDP) grew 4.1% in the second quarter of 2018, the highest pace since 2014, and with inflation still on the rise, the Fed will most likely deliver another three rate hikes until March 2019, while simultaneously continuing to reduce its balance sheet.
However, I think we will see a reversal of fortunes in 2019. I am certain we will see trade talks leading to agreements later this year, removing the global risk premiums. This, combined with rising growth prospects in the Eurozone, will probably lead to a recovery for the euro and the low valuation currencies mentioned above.
As an American investor, it could be very profitable to establish a “currency sandwich” if we see the weakening of the greenback I have outlined above. My top picks for such a sandwich would be (1) the euro, (2) the Swedish krona, (3) the Norwegian kroner, (4) the Japanese yen, and (5) the Polish złoty.
Protect Your Wealth from the Unexpected
Diversifying your portfolio with a variety of foreign currencies, particularly with the strategy Thomas refers to as a “currency sandwich,” can be a valuable tool to strengthen your overall portfolio. It is important, however, to make sure you do your due diligence beforehand and research the options available to you in order to take advantage of the benefits of currency diversification.
ASI has dealt in foreign exchange for many years, with over 100 currencies for exchange, and we can help you make the most of this diversification strategy. To learn more about foreign currency exchange or to start investing in foreign currencies today, please call us at 800-831-0007 or email us.