Investors should be wary about relying on the dollar “carry trade” for too long, according to Research Affiliates.
Michele Mazzoleni, vice president of the firm’s macro research team, warned that playing the strong US dollar against other currencies could be a painfully risky strategy once the Federal Reserve begins to raise the interest rate and the dollar depreciates.
Instead, long-term investors should look to diversify their portfolios by investing in emerging markets with potential for greater growth opportunities, he said.
According to his analysis, selling foreign currencies to buy dollars for its high cash interest rates—dubbed the dollar carry trade strategy—could easily backfire. This currency risk factor approach feeds on expectations of high cash rates—even if they are not currently high—and could increase investors’ exposures to the risk of a US economic slowdown, Mazzoleni said.
“The historical benefits of diversification should induce investors to consider whether it is worth concentrating their risk exposure toward the US economy.” —Michele MazzoleniInvestors should be wary that the dollar could weaken in the near future, particularly given the Federal Reserve’s stance on maintaining low interest rates, he added.
“Recognizing that a stronger dollar might harm the economic recovery, some Fed officials appear to have misgivings about raising interest rates too soon or too far,” Mazzoleni wrote. “Without positive surprises from the US economy, the ongoing appreciation of the dollar might soon come to an end.”
Furthermore, Research Affiliates warned investors of the dollar’s current overvaluation, which it said was nearly 10% more than its value in a long-run competitive market.
In addition, because the US is currently importing more than exporting, the dollar is most likely to fall in the long run, possibly followed by dangerously slow economic growth, Mazzoleni said.
“The historical benefits of diversification should induce investors to consider whether it is worth concentrating their risk exposure toward the US economy,” he said.
Because of these risks of betting on the strength of the US dollar, especially with uncertain interest rate policies ahead, the author suggested investors take advantage of opportunities in emerging markets.
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