For Two Dollar Bears, The Only Question Is How To Play The Slide

New York

Among US bond managers with the most at stake in nailing the dollar’s direction, two who stand out for their returns agree that the greenback’s slide is far from over. There’s less consensus about which currencies to favour.

The foreign-exchange strategies of the T. Rowe Price International Bond Fund and the BrandywineGLOBAL Global Opportunities Bond Fund are of note because the pair outperformed more than two-dozen rivals in the past 12 months, data compiled by Bloomberg show. That’s according to a screening of actively managed US-based bond funds with a minimum of $1 billion of assets, five years of history and more than 60 per cent of holdings in non-American debt.

The funds take a dim view of the greenback’s prospects in the coming years, even as its first monthly gain since October has them tempering that stance for now. Yet they part ways on how to navigate a longer-term dollar slide. T. Rowe says vibrant economic growth abroad and shifting expectations on monetary policy will benefit the euro and yen. For Brandywine Global, there’s more potential in European currencies beyond the 19-member bloc.

“The US is handing the leadership in the global economic cycle off to Europe and emerging markets,” said Kenneth Orchard, the London-based co-head of the $3.6 billion T. Rowe fund. What’s more, the Federal Reserve “is the first central bank to hike rates, and the Fed is going to be the first to cut.”

The Bloomberg Dollar Spot Index is down 2.6 per cent in 2018, extending last year’s 8.5 per cent slide, its steepest since at least 2004. Divining the greenback’s path is crucial to US money managers with assets overseas — when left unhedged, a weaker dollar can bolster returns on those holdings. Conversely, US currency gains could crimp performance.

Returns leaders

The T. Rowe fund returned almost 12.5 per cent for the 12 months ending Feb. 23, while Brandywine Global’s earned 11.7 per cent, Bloomberg data show. For the funds in the Bloomberg screening, which excluded those focused on emerging markets, the average was 4.4 per cent.

The T. Rowe fund invests chiefly in non-dollar bonds outside the US, with 98 per cent of assets in foreign debt as of Jan. 31, its website shows. It uses currencies to hedge, but also enters into straight foreign-exchange trades in markets that might otherwise be unattractive. That’s the case with Japan, where 10-year yields are barely above zero.

The yen is the strongest Group-of-10 currency this year, gaining 6.6 per cent to about 105.70 per dollar as investors seek a haven from recent equities turmoil. Japan’s currency accounts for slightly over 30 per cent of the fund’s foreign-exchange exposure, which Orchard said is above the weighting in its benchmark, an unhedged Bloomberg Barclays Global Aggregate index.

Kuroda Spark

Eventually, expectations for diminished Bank of Japan accommodation will take over as a driver, he expects. The yen gained Friday after BOJ Governor Haruhiko Kuroda said the bank will start thinking about how to exit monetary-stimulus program around the fiscal year starting in April 2019.

“As we get to the end of the US economic cycle and if the global economic cycle can last long enough, then eventually we should start to see some normalisation out of the BOJ,” Orchard said.

As for the euro, it could benefit from the potential for the European Central Bank to tighten policy, in Orchard’s view. Though T. Rowe is underweight the euro amid market turbulence, it’s bullish on a longer horizon. Its euro weighting is a bit under 40 per cent, he said, compared with about 45 per cent for the benchmark.

Even after rallying against the dollar in 2017, the euro is below the $1.25 level that T. Rowe estimates as fair value, and he predicts it could exceed that mark.

“Growth in Europe is very strong, so there’s no reason why not to expect that growth cycle to persist longer than the US cycle,” said Orchard. “The $1.40 to $1.50 range would seem fair for the multi-year view.”

Crowd Avoidance

Jack McIntyre, a portfolio manager on the $3.6 billion Brandywine Global fund, isn’t convinced.

For him, even though the euro-zone economy is performing well, the long-euro trade has grown crowded.

Brandywine Global prefers to capture Euro-area growth through currencies that leverage that strength and that he considers undervalued, such as the Polish zloty, Norwegian krone, Swedish krona and the British pound. The fund’s top region by currency as of Jan. 31, with about a 37 per cent weighting, was Europe ex-Eurozone, according to its website.

“Along the relative value theme, some of these non-euro European currencies should do better than the euro,” said McIntyre, who’s based in Philadelphia. He benchmarks his fund against an unhedged FTSE world government bond index.

When it comes to the yen, Brandywine Global is reducing an underweight as the currency gets a boost from the latest bout of market volatility. But, in an interview before Kuroda’s Friday remarks, he said he expects BOJ stimulus to continue for years. Japan ranked fifth in terms of the fund’s top region by currency as of the end of January.

He’s finding value in developing economies, reducing duration in “overvalued” Group-of-10 bond markets in favour of higher-yielding emerging markets such as Brazil and Mexico.

For now, he’s been adding dollars, bracing for a “counter-trend move.” But the fund remains underweight.

“This is a multi-year phenomenon,” he said. “There’s better relative growth outside the US and I think capital will gravitate towards those types of countries.”