ECB vs. Fed Why the US dollar is rising – and what that means for investors

ECB vs. Fed Why the US dollar is rising – and what that means for investors

ECB vs. Fed Why the US dollar is rising - and what that means for investors

Many Americans are likely to get horror at the moment when they look at them. The and thus at the highest value for almost four decades. The one by raising interest rates – even if it risks putting a strain on the economy. At the Fed meeting on Wednesday, Fed Chairman Jerome Powell could finally make an announcement when the first rate hike is planned.

The European currency watchdogs are also meeting this week, one day later than their US counterparts. So far, however, they have shown themselves to be much more cautious when it comes to tightening their ultra-loose ones. Unlike the Fed, it is only very hesitant to reduce its bond purchases. Despite growing fears of inflation, there are no signs of rising interest rates in Europe. “Monetary policy is drifting apart,” comments Holger Schmieding, chief economist at the private bank Berenberg.

The different speeds of the central banks mean that the euro and the US dollar are increasingly diverging. Should the Fed and this week act as expected, one should tighten its monetary policy further, while the other will remain more passive. This could widen the gap between the two currencies. This has concrete consequences for the citizens of the euro area, both as consumers and as investors.

America trips are getting more expensive

The dollar has appreciated significantly against the euro in recent months. For one euro, US investors currently only have to pay $ 1.13. In the summer it was ten US cents more at times. This development is indirectly a consequence of monetary policy. Many investors now prefer to invest their money in the USA, where it already pays more interest than in many countries in the euro zone. The yield on US government bonds with a ten-year term is currently 1.44 percent – that of ten-year German government bonds is minus 0.36 percent.

The currency difference is felt most directly for travelers to America. You can now buy less for your euros in the US than a few months ago. Even those who stay in the euro area will not be spared: a strong dollar means higher prices at the petrol station. Because oil is traded in US currency on world markets.

The stumbling euro does not only have losers. A weak domestic currency is an advantage for companies exporting from the euro area. The reason: A cheaper euro supports the demand for European products in non-European countries. German companies in particular are strong in exports and benefit from the falling value of the euro against the dollar.

More return for the same money

The strength of the dollar is also good news for investors with a lot of US stocks in their portfolio. Because in addition to possible price gains, you can look forward to currency gains. For US stocks and bonds, the value of the dollar can make up a not insignificant part of the total return for a euro investor. For example, if the investor buys a US dollar bond and holds it to maturity, he gets the face value back. If the dollar’s rate has risen by three percent against the euro during the term, it will receive three percent more money in its home currency. There is also an exchange rate effect with stocks. If you sell US stocks while the dollar is strong, you get more money in euros.

It is difficult to make targeted use of the strength of the dollar. Investors can buy more US bonds if they assume that the dollar will perform well in relation to the euro. Or they can invest in a US equity fund or ETF with no currency hedging. In the world share index, for example, one of the most popular indices for ETFs with shares from 23 industrialized countries, US companies have an impressive 69 percent share.

“You can’t just let currency investments run for ten years,” says Ulrich Leuchtmann, Head of Currency Research at. Because at some point the dynamics in the euro-dollar currency pair will reverse again – and instead of profits, there will be exchange rate losses.

Short-term currency speculations with certificates are, in turn, very risky for private investors. Former Fed Chairman Alan Greenspan once said that if you wanted to predict exchange rates, you might as well flip a coin. “Private investors in the euro area have the problem that they can hedge against a weaker dollar, but can hardly benefit from a rising dollar,” says Leuchtmann.

Should investors at least hedge against the dollar losing value sooner or later? Probably not: So-called currency hedging costs money and thus also returns. You can see that in two exchange-traded index funds from the Blackrock subsidiary iShares.

Security eats performance

One of the two ETFs tracks the conventional global equity index MSCI World, the other tracks its currency-hedged variant MSCI World 100% Hedged to EUR. The running costs of the secured ETF are 0.55 percent, while those of the unsecured ETF are only 0.5 percent. In the past ten years, the secured index fund has achieved almost 12 percent plus per year. His unhedged brother achieved 14 percent annually. In the current year, the difference in returns is even more striking, with 20 versus 29 percent since January.

In the long term, exchange rate fluctuations are not as significant in the portfolio because gains and losses are more or less balanced. In the short term, even risk-averse investors shouldn’t bet too heavily on further currency gains from the dollar. Forex experts don’t see much room for improvement anymore. “A good part of the expectations of the central banks have already been factored in,” says Leuchtmann. Investors expected three rate hikes in the US and at most one in Europe for the coming year.

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Daniel Hartmann, chief economist at the investment company Bantleon, also no longer expects any major exchange rate jumps: “The central bank meetings in the coming days will probably not generate any new sustainable impulses for the euro / dollar currency pair.” In 2022, the gap between the two currencies should then partially close , Hartmann expects: “The euro should pick up again in the course of the coming year.” That would be good news for the next trip to the USA.

. When does the money rain stop again?