TRANSCRIPT

SPEAKER: Edmund Shing

Hello and welcome to a new podcast from BNP Paribas Wealth Management. I'm Edmund Shing, Chief Investment Officer.

Today's podcast is going to be about a weaker dollar. Why should the dollar weaken further than it already has? And what investments can benefit potentially from an even week a dollar in the future?

To start with, yes, it's true that the dollar has certainly weakened over the last few months since Donald Trump has taken office for the second time in January. 

We've seen a turnaround in the dollar. It had previously strengthened over several years and has now started to weaken quite considerably with the euro dollar rate. Now at over one spot 13 dollars per one euro, not that long ago, we were thinking about parity between the euro and the dollar. So really quite a big turnaround for the dollar in just a few months. 

Why do we believe the dollar can weaken further from here, after what has already been quite a pronounced period of weakness?

Four reasons for this. 

Firstly, the ongoing worries over the US federal debt burden. We have a new tax cutting bill passing through Congress, which suggests that the fiscal deficit will widen yet further. That means the US government will need to borrow yet more money to fund, spending that it does not cover with tax revenues. This is undermining the safe
haven status of US assets, predominantly US government bonds. And by extension, is undermining therefore the dollar, because the dollar and dollar assets are no longer seen as such safe havens in difficult times. 

Secondly, the US economy itself is seeing slowing growth. Yes, the second quarter will probably see better growth than the first quarter, but make no mistake, the growth trajectory of the US is clearly slowing, driven particularly by the consumer. Remember that nearly 70% of the US economy revolves around consumption and US households are seeing slowing trends in consumption growth, notably because they are seeing rising prices. And secondly, because unemployment is rising. So there are two reasons there for consumers to feel a little bit less confident about the future. And therefore, we expect consumption to slow, which will in turn slow the US economy, which again should in time weigh on the US dollar.

Thirdly, we are seeing increased repatriation of assets held in the US by foreign investors, notably pension funds, insurance companies and the like, they are starting to repatriate these US assets back to their home countries, notably to Europe and to Asia. So that involves selling of US assets, bonds and stocks, and buying of local assets in Europe or Asia. Of course, this is therefore a drag on the dollar, because by extension, you're selling the dollar to buy your home currency more and more. This trend has merely started. We think there is a long way to go with a potential repatriation of US assets back to Europe and Asia. And so we think this will continue to be a long term drag on demand for the US dollar. And finally, even if you are continuing as a foreign investor to hold assets in the US, you are much more likely to want to currency hedge those assets to protect against a further weakening in the dollar. Up to now, foreign investors had not been fully hedged and been largely unhedged because of course, the dollar was strengthening on average against most currencies for the past 10 years or so. So, most of the time, if you are unhedged as a euro based or as an Asian based investor, you made money not only by holding US stocks and bonds, but most importantly also via holding US dollars on an unhedged basis, because you benefited from the appreciation also from the currency. This of course is no longer true, hence the need to protect yourself by currency hedging your remaining US assets. So, for all these four reasons, we expect the dollar to continue to weaken structurally. 

There is of course a fifth reason, which is a political reason. Donald Trump himself wants a weaker dollar to support his policy of reindustrializing the US economy to make US exports more competitive. And to do that, he would like a weaker dollar because that favors US exports over foreign imports into the US. 

Assuming that the dollar does get weaker from here, what assets can benefit what investments do you want to be looking at today, which should benefit from a following wind of a weaker dollar in the future.

Well, firstly commodities, clearly precious metals. In the short term, there is a clear inverse correlation between gold and the dollar. When the dollar goes down, gold tends to go up. Yes, I know gold has already performed incredibly well over the last couple of years, but I still think there's more potential for an upside in the event of a weaker dollar. Again, very few safe havens out there. Gold remains one clear, long term safe haven for investors. But also, within commodities, we can think about copper and other base metals and also agricultural products. All of these should benefit from a weaker dollar. This should boost demand for these products. And we expect that to play a role going forward. So therefore, not just precious metals, but also think about base metals such as copper as an interesting investment in the event of a weaker dollar.

Outside of commodities, let's look at emerging markets, both equities and bonds. Again, they tend to benefit from a weaker dollar and a strengthening local currency.
For instance, emerging market debt tends to well sovereign debt, which can be priced either in dollars or in local currency. And clearly, to benefit from the currency weakness in the dollar, you would want to buy emerging market bonds in local currency. Emerging market equities, such as the MSCI Emerging Market Index, should also benefit from a weaker dollar.

On top of that, we can look at international equities. So, what do I mean by international equities? We mean the rest of the developed world outside of the US, particularly Canada, Australia and the Eurozone. These three should do well, Canada, because obviously not only should it benefit from the currency, but also from a boost to commodity prices. The same, of course, goes for Australia, which is also pretty commodity heavy in terms of stock exposure. And for the Eurozone, we expect to see a positive domestic dynamic in terms of infrastructure spending and defense spending, helping the local economy lower interest rates from the ECB with also help. So that is happening. 

But on top of that, you have this repatriation effect, which should drive European institutional investors to bring money back from the US and reinvest it in European stocks and bonds. 

Finally, we can think about companies in Europe, for instance, that have costs in US dollars, and those costs therefore will be going down as the dollar gets weaker but have revenues in euros or in other currencies. The classic sector to think about is the media sector, because they actually buy a lot of media, for instance, television, programs or films from the US in dollars, but generate revenues typically in euros. So again, they should benefit from a weaker dollar. 

And finally, you could think about certain US companies, which are very export driven, particularly commodity related companies, who should benefit by their commodity exports becoming more competitive on an international market. The agricultural producers are interesting names here, as are linked fertilizer names. And this is a sector that has started after a long period of underperformance has started to perform a lot better in the US. I think again, a weaker dollar could continue to be beneficial for this segment going ahead. 

So there you have it, five ideas, just to summarize commodities, precious metals and base metals in particular, emerging market equities and bonds, international equities, particularly in Canada, Australia and the Eurozone, and finally, European companies with costs in dollars and revenues in euros such as media companies.

Thank you very much for listening to this podcast from BNP Paribas Wealth Management. Please do like, share and subscribe to our series of podcasts. And until next week, thank you for listening and goodbye.