How rising exchange rates could affect U.S. investments
Last month, the Bank of Jamaica (BOJ) adjusted its monetary policy to tackle inflation, which had exceeded the target.
In January 2022, the inflation rate of 9.7% remained above the upper limit of the central bank’s target range. And that should continue over the next 10 to 12 months.
So how will this affect long-term investments for those trading in the US market?
Eugene Stanley, vice president of fixed income and foreign exchange at Sterling Asset Management, shares his thoughts on rising exchange rates and BOJ monetary policy.
“As to how this will affect an investor in the United States, I am not particularly convinced that it will make a big difference. The truth is that the United States, like many other countries and markets around the world, is also facing rising inflation. Other central banks are also taking steps to raise rates to try to curb inflation,” he said.
So that translates to higher returns on U.S. dollar assets, Stanley noted.
“This is also happening here where we are seeing higher returns on Jamaican dollar assets as the central bank has been forced to raise its policy rate to deal with the inflation situation,” he added. .
Sterling Asset Management is a full-service financial planner, fund manager and global securities trader focusing primarily on US dollar-denominated fixed income securities. The company partners with leading brokerages to connect investors to the global capital market, offering attractive returns for medium to long-term investments, including global US dollar bonds and mutual funds.
The BOJ would have accelerated its rate of hike – it raised its key rate by 150 basis points to bring its signal rate to 4%, but given that the Jamaican authorities are still targeting inflation between, say, 4 and 6% , the United States is aiming for inflation of around 2%.
According to Stanley, what this means for investors is that the value of the Jamaican dollar, given the inflation differential, can be expected to depreciate on an annual basis between 2% and 4%. .
The tougher BOJ measures are also aimed at addressing expanding liquidity in Jamaican dollars and maintaining stability in the foreign exchange market.
Stanley applauded the BOJ’s policy to deal with the situation, warning: “They have to try to contain inflationary impulses for sure, but what I want to guard against is the need to be ultra – aggressive in trying to contain inflation. I don’t think the central bank wants interest rates to return to the kind of levels we’ve seen in the past — it would certainly undermine the growth the economy has enjoyed in recent years.
Although US authorities have yet to raise interest rates, they have signaled their intention to do so and have already significantly reduced liquidity support to their banking sector.
“Looking at the US market, that means there is less money available to chase financial assets, so invariably with higher interest rates, asset prices are likely to fall. This not only includes bonds which have an inverse relationship with interest rates, but also equities, as future cash flows are discounted at higher interest rates and result in lower valuations.
So, generally speaking, prices of financial assets will fall as interest rates rise in the United States.
“But ultimately, once interest rates stabilize, it will also provide opportunities for investors and they can acquire assets at prices far below what they would otherwise have,” Stanley added.
Stanley advised US dollar investors not to worry too much about current market volatility as markets fluctuate over time, but urged investors to remain vigilant.
He continued, “As long-term investors can tell you, short-term volatility doesn’t necessarily translate into low long-term returns. They favor long-term performance because it means that when there is a market pullback, a long-term investor can acquire assets at a cheaper value and thus improve the potential returns of their portfolios. Long-term investors can ride out market declines without having to sell assets.”
When the US dollar is strong, it reflects a robust US economy. On the other hand, a weak dollar can signal an economic slowdown, rising inflation, or both.
The US dollar is the world’s main reserve currency and will therefore be affected by developments in other markets.
“For example, if there is good news in Europe, the euro will strengthen against the dollar. It is difficult to develop an investment thesis based solely on the strength of the US dollar. Whether the dollar is strong or no, it shouldn’t deter investors from thinking about their future I think the most important thing is to determine whether or not this investment in US dollars achieves their hurdle rate and also compensates them for the level of risk that they are about to take,” Stanley pointed out.