A foreign exchange survey from discount broker Hargreaves Lansdown found that respondents expect lively currency markets in 2017. Factors which influence currency movements, including politics, interest rates, inflation and growth, are all largely unknown, with ongoing major geopolitical events such as Brexit negotiations and the shape of Donald Trump’s presidency, adding to the uncertainty.
Currency-hedged ETFs may help investors mitigate the risk of adverse currency movements impacting their portfolio, while currency ETFs may be used to express tactical views.
In the face of such potential volatility, investors may wish to turn to currency-hedged exchange-traded funds to mitigate the risk of adverse currency movements impacting their portfolio, or use currency ETFs to express tactical views.
The survey was conducted in December with 21 respondents including strategists, economists and fund managers.
Most respondents estimate UK growth will reach between 1.1 and 1.5% next year, and inflation will be higher than the 2% target.
Many factors are set to weigh on the Sterling currency: the most significant was deemed to be the developments in Brexit negotiations. Article 50, which signals the start of talks to leave the EU and is set to be triggered at the end of March, was second on the list. Economic factors: wage growth, consumer spending, international trade performance, government borrowing levels and employment growth were also seen as influencing factors, listed in order from most important to least important respectively.
The Sterling/euro exchange rate, trading at 1.18 €/£ on 29 December 2016, is predicted by the majority of respondents to strengthen to more than 1.20 €/£ by the end of next year. But a wider range of outcomes were in the mix, between 1.05 – 1.35 €/£.
A curveball for the euro could be the departure of a member country from the single currency. Half of the survey’s respondents predict this will happen within five years, and just under a quarter of respondents think it might happen between one and three years. Such an event may raise further questions about the sustainability of the monetary union and precipitate a sharp devaluation in the euro.
As for the Sterling/dollar exchange, the most influential factors for its future direction were thought to be the pace of US interest rates and the policies of new president Donald Trump, according to the survey. As the pound already sank to a three decade low against the US dollar after Brexit, some respondents said the currency has already hit rock bottom. With Brexit fears “baked in” and the prospect of constructive Brexit negotiations, many respondents predicted the pound could even rally against the dollar in 2017.
One unnamed survey respondent commented that the most important factor for the trading of the dollar will be whether President Trump can deliver his proposed fiscal stimulus in an economy that already has record-low unemployment.
“Full implementation will likely [lead to] a second material leg higher of the US dollar as the Fed is priced to react to inflationary pressures such a package would bring. However, implementation of President Trump’s protectionist and isolationist rhetoric would narrow the breadth of any dollar rally, with the Japanese yen and the euro being the beneficiaries.”
The dollar/Sterling exchange stands at 1.22 $/£ as of 29 December, and forecasts covered a wide range of possibilities. Only 5% of respondents estimated the exchange would sink as low as $1.05, while 10% estimated it would rise to as much as $1.40. The majority placed their estimates between $1.15 and $1.30.
Research indicates that exposure to foreign currencies has historically increased portfolio volatility both in the short- and long-term without significantly increasing expected returns. According to these findings, by not hedging currency risk investors are accepting greater volatility without receiving compensation in the form of the potential for greater returns.
Investors without a specific view on the direction of currency movements and who are looking to manage risk in the current volatile environment would be well placed to consider currency-hedged ETFs as a cost-effective solution. Many providers offer a range of ETFs covering all major geographic areas and asset class while hedging exposure relative to major trading currencies.
For those seeking a more elaborate strategy to currency hedging, WisdomTree offers a range of ETFs with built-in dynamic currency hedging. These funds use a rules-based analysis of key fundamental drivers of exchange rates to determine the necessity and extent of hedging required given current market conditions.
For those European investors seeking to express a direct tactical play on currency markets, ETF Securities offers an extensive suite of currency ETFs consisting of long or short positions in each of the G10 currencies versus either the dollar, British pound or euro. Boost ETP also offers a range of funds with either long or short dollar exposure versus the euro while magnifying gains or losses by a factor of four or five.