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Hedging the US dollar and delayed fiscal spending

31 March 2017

 Are you hedging the US dollar in your portfolios?

The currency exposure in a sterling based portfolio is not as simple as it may appear. At a glance, it may seem fairly easy to measure the currency exposure of a portfolio of equities, bonds, property and absolute return funds - US equity is dollar, UK equity is sterling, Japanese equity is yen and bonds are simply in their chosen currency of denomination. However, it is never quite so black and white. The FTSE 100 index has about 80% of earnings in non-sterling currency and large US companies will have sales globally. Should we consider a Swiss company, such as Nestle as Swiss Franc exposure when most of its business is spread around the world? In bond markets, currency exposure is relatively simple and currency moves can be much more impactful than the price of the bonds. Thus, as a starting point, we would normally suggest hedging bond exposure to base currency but not usually equity exposure. With that said, there are circumstances where hedging can be appropriate. In an export driven economy like Japan the fall in currency can drive the equity market up, hence there is a somewhat of a natural hedge in the Japanese equity market which can be attractive.

When we look at sterling portfolios over the Brexit period we have seen exceptional returns driven by the depreciation of sterling. This has come from UK listed companies’ foreign earnings being revalued, thus benefiting UK equity markets as well as from overseas equity. Even inflation linked gilts have benefitted as inflation is rising as a result of the currency devaluation. We are very conscious of these factors when looking at portfolios and endeavour to assess the direct and indirect currency exposure. As far as the dollar is concerned, it has often been a safe haven at times of trouble and the currency strength has helped when markets fall. At present we do not suggest hedging the dollar equity exposure in portfolios but, given the size of the move, we are monitoring the portfolios closely. For those looking to reduce currency risk in portfolios we could buy currency hedged versions of equity funds to reduce the risk of a reversal in sterling if Brexit negotiations look as if they are going well.

With continued delays in fiscal spending announcements is there sufficient monetary impulse to satisfy global growth and inflation expectations as being discounted in markets?

At the end of last year there was a lot of talk of a shift from monetary to fiscal stimulus with frequent questions asked on how much could be done given the size of government deficits. The UK autumn statement and the subsequent spring budget did not indicate a big spending increase. With Brexit negotiations pending, the Chancellor appears to be trying to keep his powder dry. In Europe, deficits and Euro membership rules constrain how much can be done. In the US, Trump has talked about reducing tax and increasing spending on infrastructure, he was planning to fund part of this from reduced spending on Obama care. The rejection of his healthcare reforms may make his budget and debt ceiling negotiations harder.

In any event, economic survey data is indicating stronger growth around the world. In the US interest rates are moving higher. This rate move has, so far, been priced in by markets without damaging equity markets. This additional spending may not be a condition of continued global economic recovery. Bill Dudley, President of the Federal Reserve Bank of New York, commented on further fiscal stimulus, suggesting that the risks were gradually shifting to the upside for growth and inflation.


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