Declining dollar makes foreign investments lucrative
© St. Petersburg Times
Our foreign policy isn't the only thing taking a beating in Europe. The U.S. dollar is getting battered,too. Since its peak a year-and-a-half ago, the dollar has lost a fourth of its value against the euro, the 4-year-old European currency.
But bad news for the dollar is good news for some U.S. investors, who are discovering ways to capitalize on the dollar's weakness and the higher interest rates available overseas.
Those bold enough to make the move last year have been richly rewarded. In the past year, international bond funds were up an average of 19 percent, second only to gold funds among the mutual fund sectors tracked by Morningstar.
While predicting currency movements is never a sure bet, many market watchers say this trend is a long way from being over.
"We believe we're about one year into a multiyear decline in the U.S. dollar," said Frank Trotter, president of Everbank, an online bank that specializes in foreign currency accounts. The unusual bank, which has its headquarters in St. Louis, offers accounts in euros, Norwegian krone, Mexican pesos and many other currencies.
Trotter said the bank's foreign-denominated deposits have doubled in the past year to $165-million. The six-month CD offerings recently available included the Japanese yen at 0.01 percent, the euro at 2.11 percent, the New Zealand dollar at 5.06 percent, the Mexican peso at 7.25 percent and the South African rand at 12.1 percent.
Although it is among the lower-yielding offerings, the euro is by far the most popular choice, Trotter said. That's because most investors who open accounts are only secondarily concerned about interest earnings. Their primary goal is to make money on changes in the exchange rate, by holding the favored currency until they think it's an opportune time to convert back into dollars. They pay an exchange fee of 0.75 percent in each direction. To them the euro looks strongest.
In effect, the euro has become a default choice for investors who do not want to hold Japanese yen or U.S. dollars.
"It's the lesser of three evils," said Ian Kelson, who manages the $1.2-billion T. Rowe Price International Bond Fund from London. "The case for the weak dollar and the strong euro is not at all to do with anything very good in (the economy of) Europe, which if anything has weaker growth than in the U.S."
Part of what's wrong with the dollar is the political and economic uncertainty created by the threat of terrorism and war with Iraq. However, the reasons for the dollar's fall go much deeper and are not likely to be quickly resolved.
"Usually when there is some sort of conflict, the dollar is seen as a safe haven -- except when the conflict involves the U.S.," said Scott Brown, economist for Raymond James & Associates in St. Petersburg. "Venezuela, Iraq and North Korea are all U.S. problems. If we get a solution to the Iraq conflict, things clear up in Venezuela and we get some dialogue with North Koreans, we could get some short-term improvement in the dollar. But long-term trends will be in place for a while."
Some describe the dollar's decline as inevitable. Like a pendulum, the dollar could go only so far in one direction before it had to swing back the other way. As the dollar strengthened, U.S. goods became increasingly expensive overseas, exports fell and manufacturers suffered. The weakening dollar has begun to produce a pickup in foreign sales, although that is being tempered to some extent by weak economies around the world.
"This is a natural process," said Michael Hasenstab, portfolio manager of the Franklin Templeton Hard Currency Fund in San Mateo, Calif. "Revaluation of the U.S. dollar could be beneficial to the U.S. economy by helping export growth. These macro adjustments tend to move toward equilibrium. We don't know when we will reach that equilibrium, but the pressures that have driven the U.S. dollar to these levels are still in place."
At the root of the dollar's woes is the current account deficit, the government's way of tracking money flowing into and out of the country through trade and investment. So many more dollars are flowing out that the deficit has now reached 5 percent of U.S. economic output, high enough to make investors nervous. Europe, by contrast, has a surplus.
Three big trends have contributed to the problem:
-- The balance of trade is off because U.S. manufacturers cannot sell enough U.S. goods overseas to keep pace with the U.S. consumer's appetite for foreign goods.
-- For years the trade deficit was offset by foreign investors making equity investments in the United States, buying stocks and direct interests in U.S. companies and real estate. In effect, the extra dollars we sent overseas to buy foreign goods came back to us as equity investments. But after three years of stock market decline, accounting scandals and a weaker economy, the equity inflows have dwindled.
-- U.S. interest rates are so low that foreign investors are losing their appetite for U.S. bonds. At the same time, the federal budget has moved from a surplus to a deficit, creating a need to sell more bonds. Ultimately that imbalance could lead to higher interest rates, although at least for now, U.S. investors are making up the difference by putting their money in bonds instead of stocks.
"At precisely the time that people lost confidence in the U.S. economy and stock market and became less willing to make equity investments, yields on U.S. assets fell to very low levels," said Kelson at T. Rowe Price. "Low interest rates are absolutely right for the current U.S. economic climate, but they're not at all helpful in promoting a dollar recovery."
Interest rates also have been coming down in Europe; the European Central Bank has lowered rates partly because of concerns that the strong euro will hurt manufacturing exports. But the rate decline has not occurred as quickly as in the United States, which means European rates still have room to fall. If they do, that could give foreign bonds another boost.
Once the economy begins to improve, interest rates are expected to pick back up, both in the United States and abroad. If that happens, bond prices will fall since interest rates and bond prices move in opposite directions. The longer the term of the bond, the more its price is affected by interest-rate swings.
"I think U.S. bonds are the most vulnerable, but European bonds are potentially vulnerable too," Kelson said. "Our view is that this is not the moment to be very aggressive in terms of duration. It's much nearer the end game in terms of the interest rate cycle."
One way to skirt interest rate risk is to stick with very short-term investments, such as the Everbank CDs or the Franklin Templeton Hard Currency Fund, which keeps the average maturity of the securities it owns at 120 days or less.
"We're not looking to take interest rate risk," portfolio manager Hasenstab said. "Our financial advisers are showing this fund to clients as a hedge against the U.S. dollar" declining. He said the fund is making its biggest bets on the euro, the Swiss frank, Danish Krone and New Zealand, Australian and Canadian dollars.
Investing in foreign currencies and bonds remains a foreign concept for most U.S. investors.
"So far investors are not clamoring for it," said Greg Ghodsi, a stockbroker with Robert W. Baird & Co. in Tampa. "But in doing portfolio reviews, some ask what's going on with the dollar."
Investors who want to bet against the dollar have to be prepared for fluctuations in the value of their investments. The Everbank CDs carry FDIC insurance against bank insolvency, but there is no protection from losses if the dollar strengthens when you bet it would get weaker.
Some types of investments are more volatile than others. Broker Ghodsi said the safety-conscious investor should avoid individual foreign bonds, which have big price swings and may be difficult to sell.
"I don't think the typical investor would want to buy something at 100 (dollars per $100 of face value), see it go to 40 and then back up to 80," he said.
Ghodsi prefers mutual funds for foreign bond investments. He suggests investing through closed-end bond funds, which trade like shares of stock on the New York Stock Exchange and other exchanges. Because they do trade, it is possible to limit losses by setting up a standing order with a broker that will trigger the sale of the bond fund if the share price falls below a certain level.
Before buying any bond fund, investors should check to be sure its investing style matches their objectives. Some foreign funds hedge against currency fluctuations so you don't get big losses on the dollar's movements, but neither do you get big gains.
Foreign bonds and bond funds have not been particularly popular with U.S. investors for good reason: When the dollar was strong, they lost money. In addition, many investors prefer to keep their money closer to home.
For those willing to take the risk, putting some money in foreign income investments will diversify a portfolio since foreign bonds do not move up and down in synch with U.S. investments.
-- Helen Huntley can be reached at firstname.lastname@example.org
or (727) 893-8230.
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