Sep 09, 2019 Equities

Weaponise currencies? No winners – but investment risk increases

The trade dispute between the USA, China and the EU is currently intensifying and threatens to turn into an all-out currency war. The warning signs are multiplying. Investors should therefore get ready for increased stock-market fluctuations.

  • The USA is considering weakening the dollar to improve its economy. This would benefit the country’s exports.
  • However, other regions – such as Europe and China – would suffer. This could provoke a depreciation race.
  • In the long-term, there are no winners in such a race, as it leaves companies with no reliable basis for planning. The uncertainty may also affect stock markets.
5 minutes to read

“Currency manipulation!” This accusation, directed at China by US President Donald Trump in August 2019 on Twitter, is a serious one. He alleges that the government in Beijing deliberately pushed the Chinese currency, the Renminbi, to its lowest level in several years, thereby causing the US dollar’s value to soar. All this was supposedly retaliation in China’s ongoing trade war with the USA.

The trade war, which has been ramping up for some time, could now escalate into an all-out currency war, and investors should consider this when allocating capital. Currency upheavals could have a direct effect on corporate profits, and so in future stock markets will probably be more sensitive to news about the tussle between the world’s two largest economies.

Donald Trump wants to win a second term in next year's presidential election and to do that he needs a strong economy.

Weak dollar, better export figures

Donald Trump, who is campaigning for re-election next year, needs a thriving US economy, and the strong dollar is a problem for him. It makes US products costlier on the world stage – a clear advantage for other countries and hardly an election winner for Trump. He has therefore put pressure on the US Federal Reserve Bank (Fed) to lower interest rates, which may weaken the dollar.

“The Fed already reduced its base rate in July to improve the economy,” says DWS currency expert Stefanie Holtze-Jen. “However, the dollar didn’t weaken, partly because it’s seen as a ‘safe haven’[1]

by international investors and US interest rates are still relatively high compared to other countries’ rates.”. 

Trump’s wrath is directed at Europe too

The European Union has also accused Trump of unfairly influencing its currency. The Euro’s value has indeed been falling continually for more than a year. And interest rates are also going down on this side of the Atlantic, which might weaken the Euro even further. In mid-August, it was at a level last seen in 2017.

“What the US President fails to mention in his rebuke is that currency always reflects a country’s current economic position as well,” says Holtze-Jen. “And when it comes to the economy, Europe is currently playing catch-up with the USA.”

Stock brokers fear a depreciation race

In view of the Renminbi and Euro’s current weakness, experts are increasingly worried that the USA will attempt to weaken the dollar in turn. Currency depreciation can benefit a single national economy. However, a depreciation race between several countries and regions will not help anyone in the long run.

 Stock markets have already shown that the global economy and equities will probably both suffer if there is a protracted currency war. Equity markets reacted strongly to Trump’s accusation of manipulation and started trending downwards. Investors can therefore already feel the consequences of the showdown.

International currency fluctuations tend to subdue economic development, because companies have a less secure basis on which to plan. “It is more difficult for companies to deal with a weakening global economy when they are also facing currency challenges,” says Holtze-Jen. For example, raw materials for productionmay suddenly become much more expensive as a result of currency movements. This complicates purchase planning.

Households may also suffer from rapidly rising prices. A weak national currency means consumers pay more for imported goods. Their purchasing power falls, which in turn dampens domestic consumption and may have a negative impact on corporate profits.

Currency upheavals have a direct effect on portfolios

In addition to negative economic consequences, which may affect the equity markets, there is another possible consequence of currency fluctuations that investors should keep in mind. If, for example, an investor in the Eurozone purchases US shares and the dollar weakens, those shares’ value in euros falls too. Eurozone investors could therefore make a loss on US shares, even though the price on Wall Street is rising. Conversely, should the dollar increase in value, as has been the case since spring 2018, that has a positive effect on their holdings.

As it is very difficult for investors to predict exchange rate changes, they should construct globally diversified portfolios. That way, individual currency fluctuations have less impact.

The USA could intervene directly on the foreign exchange market

In Stefanie Holtze-Jen’s view: “It is difficult to say who would win a currency race.” She advises investors to assume that the fluctuation range on the currency markets will be broader in future. She predicts that the Euro will settle at a value of 1.15 US dollars within the next year, because the USA currently has more leeway than Europe to make further cuts to the base rate.

However, Holtze-Jen also notes that it remains to be seen whether the Fed, which is technically independent, will allow the US president to draw it into a depreciation race. The US government could also intervene directly on the foreign exchange markets and attempt to devalue the currency by selling US dollars. Either way, Holtze-Jen says that “a trade war that turns into a currency war is a serious matter, not a passing shower”.

The dollar has not yet weakened

Meanwhile, the dollar still shows no sign of weakening. And so perhaps the US government will conclude that a depreciation race will hurt the global economy – and thereby hurt US companies too.

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