The Federal Reserve went back to a holding pattern on interest rates on Wednesday after a series of cuts at the three previous meetings. The decision to hold the benchmark federal funds interest rate steady could be a sign that the Fed is trying to bolster the dollar to keep international investors interested in U.S. Treasury bonds and the stock market.
The dollar’s strength over the past decade was largely due to the outperformance of the U.S. economy and markets compared with the rest of the developed world.
But this “strong dollar, strong country” is at odds with some in the White House and the market as the U.S. dollar fell to its lowest level in four years on Tuesday. The currency, last year, posted its worst annual performance since 2017. The dollar-euro exchange rate is a key barometer, and the greenback has lost about 14% of its value relative to the euro over the past year.
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The normally slow-moving Japanese financial markets are more volatile, and the yen could be strengthening as Japanese interest rates rise. This is reducing the price of Japanese government bonds as the days of zero interest rates give way to 4% rates on long-term bonds. The yen-dollar rate is critical, and Japanese investors are starting to come home as its stock market outperforms the S&P 500 and world indexes.
Japan is joining America in worrying about inflation while China struggles with deflationary lower prices due to slumping property markets, hypercompetition and slower economic growth. We can try to hide from the world trends and events, but the international impact on stock values is indisputable, as you can see from this chart of Japanese international holdings.
International investors are big drivers of our bull market, and keeping them interested in investing in American stocks and government Treasury bonds is critical. Investors look for total return, and this includes interest payments and, importantly, the exchange rate. The appreciation of the Swiss franc, for instance, has been worth much more than the higher U.S. bond yield.
Also important, dollar weakness benefits China. China has been selling U.S. Treasurys in favor of gold, enjoying a much better return as gold has soared and the dollar weakened. It is already one of the world’s biggest producers of silver, which has soared during dollar weakness.
Even the conservative Japanese life insurance companies, which hold the equivalent of more than $2 trillion in securities, are reconsidering reliance on foreign markets as interest rates at home become more attractive and Japanese stocks show some momentum.
Europe and Japan are also both big holders of U.S. Treasury bonds, as you can see from the chart below from the Financial Times.
In addition, Europeans are also active players in U.S. stocks, holding about $10 trillion in stocks. You can see from the following graph from the Federal Reserve that shows that this is about as much as the rest of the world combined.
In contrast, American investors tend to invest closer to home. This is understandable, as American stocks have done well, but international stocks did better last year, and this trend may continue. To preserve and grow your portfolio, stay on the lookout for international opportunities.
Preparing for Both a Weaker and Stable Dollar
The upshot is that you need to prepare and protect your portfolio for both a weaker and stable dollar, and the Cabot Explorer can help you navigate global trends.
For example, Santander (SAN) is a remarkable Spanish bank up over 140% in the last year.
Coeur Mining (CDE) shares are a juggernaut, up another 15.6% last week and over 284% over the last year. The CurrencyShares Swiss Franc Trust (FXF) position is up about 18% over the last year while the dollar has declined 11%.
To learn more about how Cabot Explorer is managing these risks, subscribe today.
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