In this week’s video, James Klempster discusses what has driven the dollar weakness, will this be sustained and what this could mean for investors.
James: Hello, it's Friday, the 27th of June. The main news this week of course, being the strike of US on Iranian nuclear facilities last weekend. It was daring and spectacular in many ways and unexpected perhaps, because the President publicly, and we mentioned it in the video last week, gave himself a two-week window to decide what to do. And in the end, he only really needed two days. The efficacy of the strike remains to be seen, although clearly damage has been done. But most importantly, what has happened, and from a geopolitical standpoint and indeed a market standpoint, it's welcome. It's created some degree of de-escalation of tensions in the region, most notably a ceasefire between Israel and Iran. And the result of that has been really, firstly, markets have been reacting a little bit positively, although there wasn't a lot of bad news in the price from the week before to unwind, so the market response has been relatively muted. However, oil has come down quite substantially. So it was pushing up towards $80 a barrel Brent crude last week and that's pulled back down to $60 a barrel. So a substantial decrease in the price of oil over the last few days. Why that matters is really coming back to inflation. Energy is a volatile element of headline inflation in particular. When it goes up, it pushes inflation up, and as it comes down, it's likely to have either a less inflationary impact or potentially even a deflationary impact. Now, it's not expected you'll see deflation in the US anytime soon. There's plenty of other inflationary features out there, but it can take some of the inflationary pressure away. And why that matters of course, is it gives arguably more space for central banks to be relaxed about inflation and start pulling down interest rates. We're already in an interest rate cutting path, although the president of the US, Donald Trump, is clearly keen to see the pace of that increase.
Market pricing of interest rate cuts currently suggest around about 60 basis points, which is 0.6% of interest-rate cuts at the base rate between now and the end of the year. The thing about market pricing, as we've seen over the last few years, it's often pretty wrong. You only need to cast your mind back to 2024 to remember there was a huge number of rate cuts expected at the start of that year. And as the year progressed, the expectations became far less and the reality was you know materially fewer interest rate cuts than were expected at the start of the year, but still the direction of travel is pretty clear.
The President really wants the Federal Reserve to get going. He's been very public about this and indeed has referred to Jerome Powell, the Chair of the Federal Reserve, as 'stupid', amongst other things, suggesting that he's not being quick enough in cutting interest rates. There is some speculation that Donald Trump could try and accelerate Jerome Powell's departure or at least announce his successor very soon. And it has seen the dollar actually fall to a three-year low against other major currencies.
Why this matters is ultimately, when you think about government finances and currencies, fiat currencies as they're known these days, since the abolition of the gold standard, there's no sort of singular asset sat behind them. Ultimately, it's based on trust. Trust us, we'll pay you. And the difficulty with trust is, of course, that it can evaporate pretty quickly. We've seen many examples of that in the last few years, even in the UK with Liz Truss's mini-budget. The currency weakened and yields spread out pretty aggressively on government bonds because there was a broad belief in markets that the balance of taxation and spending was going the wrong way and the servicing of debt would become problematic.
There are some signs in the US in terms of the fiscal deficit. It's still the biggest economy in the world. It still has a very high-quality debtor, but you can imagine a scenario in the future where you continue to see these small shavings away of confidence, and that could lead at some point to a crisis of confidence down the track, which is still, as I say, a long way away from there. And clearly, when it comes to these currencies, there isn't really a major alternative today.
In terms of our portfolios and how we're positioned, the impact of this is actually relatively modest for us. We've got global fixed income allocations; we hedge the currency out. That means we remove the currency risks. And so we don't get that headwind from currency or tailwind from current moves in the fixed income piece. The reason we do that really is because the currency moves can create quite a lot of volatility and sort of taint that low volatility exposure you're expecting to get from fixed income. And within equities we do not hedge the currency, we do get that come through in the pricing of the assets we buy as we translate them into sterling terms. But our US allocation is relatively low, certainly much lower than it would be on a market capitalization weighted basis, a sort of naive price-taking basis. And so the impact from the weakening of the US dollar in our portfolios and Funds has actually been relatively modest. That's it from me. Have a good weekend when you get there and we'll see you next time.
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