By MARK HINTON 01/12/2006
The Dollar continued its decline this week, hitting a 14-year low at $1.97 to the Pound with analysts predicting that the $2 barrier could soon be broken. The last time the Dollar hit this low was September 1992, when Britain was forced out of the European Exchange Rate Mechanism.
| "This is great news for shoppers, but not so good for investors..." |
This is great news If you’re heading off to the US for a winter break, shopping will be even cheaper than usual. However, a weak Dollar is not so welcome for UK investors with exposure to the US, as it reduces the value of those investments when converted back to Sterling.
It’s important not to neglect the impact currency movements can have on your portfolio. The chart below shows how the Dollar and Euro have moved against the Pound over the last five years:
The Dollar has fallen around 27% versus the Pound over this period, hitting US funds in your portfolio by the same amount independently of stockmarket returns. Conversely the Euro has appreciated about 9% versus the Pound, boosting performance of European funds priced in Sterling.
Currency movements can impact UK funds too, as many UK companies generate significant revenues overseas in foreign currencies. Overseas sales of non-financial FTSE 100 companies now account for around 60% of their revenues are in the UK. A weak Dollar hurts these companies too, as any overseas Dollar revenues will be worth less when exchanged into Pounds.
Is the Dollar likely to slide further? Or will it strengthen and boost your portfolio returns?
The biggest cloud hanging over the US is its major fiscal and trade deficits, but each potentially pulls the Dollar is a different direction.
The 2005 US fiscal deficit (i.e. government spending in excess of taxes raised) was $319 billion and there’s little indication this will fall significantly anytime soon. The Government normally finances deficits by issuing more debt, which tends to put an upward pressure on interest rates. While this hasn’t been the case recently, due to strong demand for US Government bonds from the Chinese (investing their vast $ surpluses), if interest rates do rise this should strengthen the Dollar.
Meanwhile, the US trade deficit with China is well on course to exceed last year’s record $202 billion. This suggests the Dollar must further weaken, making imports more expensive for US consumers and US exports cheaper, if the deficit is to narrow.
| "These are compelling reasons for thinking the Dollar could both strengthen and weaken..." |
These are compelling reasons for thinking the Dollar could both strengthen and weaken and it’s hard to know which will prevail. Provided your portfolio does not have excessive US exposure then any further weakening should be bearable. However, if you are especially concerned then a US fund that removes currency risk through hedging, such as Franklin Mutual Shares, might appeal.