Exchange rates are constantly on the move. Philipp Dobbert, our chief economist and head of wealth management, explains why the euro has been showing weakness against the dollar this year – and why that isn't at all bad for the equity portfolio at quirion.
The euro lost a lot of value against the US dollar, especially over the summer. The media even talked of a „flight from the single currency“. What happened?
In Germany in particular, whenever the euro weakens people are quick to question the single currency as a whole. Yet movements in exchange rates are in principle a perfectly normal thing – even if the euro's weakness against the dollar this year really is very pronounced. The development can be explained mainly by two reasons: we saw very nervous equity and bond markets in the first half of the year. In such phases of stress, the dollar regularly shows strength. Investors move capital into „safe havens“ such as US government bonds. And anyone who wants to invest in those needs dollars. Alongside this risk aspect, there's also a return aspect: key interest rates have already risen far more sharply in the US than in the eurozone. That makes bond yields in the US even more attractive by comparison.
So what does a weak euro mean for the economy and the stock markets in Europe?
For the import sector, the development is bad. Many goods and services, and not only from the US, are invoiced in dollars. Just think of commodities like oil. When the dollar is strong, you have to pay more euros for them. That then fuels inflation in Europe further – which in turn leads to more nervousness on the local stock markets. The export sector, on the other hand – and that's very important for the German economy – benefits from the euro's weakness against the dollar and other currencies. Goods from the eurozone become more affordable abroad. Prices become more competitive. Someone who perhaps hadn't been sourcing their goods from Europe until now might now decide to do so.
Conversely, is the dollar's strength then poison for the US economy?
The dollar is currently showing strength against a whole range of currencies. In that respect, the consequences for the US in foreign trade are quite considerable at the moment. Cheaper imports from the currency areas that are trading weaker have a dampening effect on inflation in the US. For US exports, the dollar's strength is admittedly negative. But the US economy is very much geared towards its domestic market.
From the economy and the markets to the portfolios at quirion: what do currency movements like these do to your portfolio?
In the short term, the development has a positive effect. The dollar's strength against the euro delivered our equity portfolio a performance contribution of around seven percent this year up to the end of August. This is where the global positioning of the portfolios and their orientation towards market capitalisation come into play. The US market is weighted at a good 50 percent in the global equity portfolio. If a portfolio is heavily invested in the dollar area, it benefits from the strength of the US currency. However, effects like these are temporary. Over the long term, they don't carry that much weight.
The exchange rate can also move in the other direction. Do you hedge the portfolios against risks like these?
Not the equity portfolios. Because that would be far too expensive and the benefit would be highly doubtful. Currency trends can be predicted just as little as any other movements on the capital markets. That's why we'd have to pursue the hedging permanently. So costs would be incurred all the time. You wouldn't have to stomach any currency losses, true – but you wouldn't make any currency gains either. The only effect would be that the fluctuations in the portfolio would be stripped of currency movements – so they'd turn out somewhat smaller. But given the usual range of fluctuation for equities, currency swings barely carry any weight. With our bond portfolio, it's a different matter.
What about bonds?
We use bonds deliberately as a stabiliser. That's because the fluctuations of bonds are usually much smaller than those of equities, but also than those of currencies. Exchange rate movements would partly undo the stabilising effect. That's why we invest in bond ETFs that either contain only euro-denominated securities or that are hedged against currency movements.
