A weaker U.S. dollar may be a consensus call for 2021, but many investors underappreciate just how steep the currency’s fall could be, warned longtime currency manager Ulf Lindahl.
In fact, the next four weeks could prove “ugly” across markets, with the potential for weakness in foreign and U.S. stocks as well as bonds, said Lindahl, who founded Currency Research Associates last year after four decades at currency manager A.G. Bisset, in an interview.
In research note earlier this week, Lindahl argued that since the value of the dollar is the world’s “most important price” a steep fall over the next six months could have ramifications for investors and companies around the world. The next four weeks “will be dangerous for those who are long dollars since the odds are high it will accelerate to the downside,” he wrote.
Lindahl has been looking for a steep dollar selloff this year, which could see the euro EURUSD, +0.19% run to $1.50, a level last seen in 2009. That would mark a rally of around 22% for the shared currency versus the dollar, which now trades north of $1.21. Investors underappreciate just how sharply the dollar can move in the early phase of what he has identified as 15-year cycle, Lindahl said (see chart below).
The ICE U.S. Dollar Index DXY, -0.22%, a measure of the currency against a basket of six major rivals, is down 0.4% so far in February after a January bounce and remains down more than 12% from its early 2020 high set during the financial turmoil caused by the initial pandemic lockdowns.
Major U.S. stock benchmarks were putting in a mixed performance on Friday, with the Dow Jones Industrial Average DJIA, +0.08% on track for a weekly gain of 0.5% as it pressed further into record territory, while the S&P 500 SPX, -0.14% was off 0.4% and the tech-heavy Nasdaq Composite COMP, +0.03% was poised for a fall of more than 1%.
Lindahl sees pressure on the dollar as foreign government bond yields rise, shedding negative interest rates. U.S. Treasury yields will be hard pressed not to also see upward pressure, particularly as the U.S. government moves to cover a growing fiscal deficit.
Meanwhile, Treasury Secretary Janet Yellen’s emphasis on the need for exchange rates to be set by the market is a sign the U.S. won’t look to step in as the dollar plummets, he said. And the Federal Reserve’s resolve to let inflation overshoot its target before taking action means that it won’t react by tightening monetary policy.
And while the European Central Bank has grumbled about a weak dollar and has shown discomfort with big euro gains, it’s unlikely to take action amid growing international appetite for diminishing the U.S. currency’s role in the global financial system, he said.
A sharp fall for the dollar, meanwhile, could be extremely painful for non-U.S. pension fund managers, dealing with capital losses on bondholdings — yields and bond prices move in opposite directions — and currency losses on U.S. stock positions, he said, noting that much of the current generation of European fund managers have never seen a sustained dollar selloff.
Moreover, rising bond yields will make it difficult to justify stretched valuations.
And that means tough times for tech stocks and the most highflying stocks. Lindahl said that calls for rotating out of tech stocks and into other things like energy, with a falling dollar set to accompany a commodities boom. Internationally, “the more you can buy stocks outside the U.S. the better you are,” he said, while in bonds investors should be in cash or very short term securities overseas with the balance in precious metals.
U.S. stocks are poised to suffer as domestic investors increase allocations of foreign stocks and foreign investors reduce U.S. allocations.
Lindahl said the biggest risk to his scenario would be a surge in inflation, say at a pace of more than 5%, as that tends to boost stocks because they are real assets. Such a development remains unlikely, he said.