Since the start of the financial crisis the issue of the dollar's weakness has been discussed ad nauseum. This year, however, the dollar is up about 3 percent against a basket of currencies of major U.S. trading partners.
What caused this appreciation? Partly, it's the growing strength of the U.S. economy which raises the possibility of the Federal Reserve scaling back its stimulus. Also notable has been Japan's dramatic commitment to monetary expansion, a policy that has driven the yen down double digits against the dollar since Prime Minister Shinzo Abe's election became likely last November. And then there are the emerging markets. In the early days of the global financial crisis five years ago, emerging markets actually had stronger monetary and fiscal fundamentals than developed markets. Their government finances were healthier and emerging-market central banks seemed reluctant to run their money-printing presses as fast as those in developed markets. While these were clear signs for emerging-market currency strength, those markets have been hurt lately by a nasty combination of disappointing growth and higher-than-desired inflation. The Brazilian real and the Indian rupee have both fallen by about 10 percent against the dollar since the middle of the first quarter.
The outlook for the next year or so still favors the dollar which is a case against making a currency play. The U.S. economy has recovered a little more robustly than most other developed economies, and emerging markets are facing headwinds -- among them weak commodity prices -- that are unlikely to abate anytime soon.
Given these recent currency swings, however, some investors might be tempted to make a short-term bet against the dollar. The euro and the yen have rebounded a little from recent lows; Brazil might raise interest rates, which could strengthen the real; and the Indian government has indicated that it wants to stop the decline of the rupee.
If the belief is that the dollar will decline in value, one possible way to make a currency play would be through international stocks. They can be affected by currency movements, though they're naturally hedged; when a country's currency declines, its stock market often rises as companies gain global competitiveness from the weakened currency. Case in point being Japan, where the stock market's recent rise far outpaced the decline in the yen, a story which illustrates why international stocks deserve a permanent place in most portfolios.
International bonds could be a better way for investors to gain exposure to currency-market movements, because their returns are driven primarily by currency movements. This is especially true of developed-market bonds, as emerging-market bonds carry risks that go beyond currency movements. Currency-market futures are another option, but their complexity makes them suitable only for the most seasoned investors.
Regardless of your view on the future strength of the dollar - or whether you even have one - seeking exposure to currency movements in your portfolio is purely optional.
Simeon Hyman is Chief Investment Officer of BloombergBlack, a new offering available by invitation to affluent investors looking for a smart, easy way to take control of their personal wealth. For more information, visit BloombergBlack.
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