What a strong US dollar means for UK investors

Sam Slator 21/09/22 in Strategy

Last week, sterling fell to $1.13 against the US dollar – a level not seen since 1985. Why? Because British consumers are cutting down on their spending as inflation strains household budgets, and this in turn is increasing concerns that a recession is looming.

And experts have predicted the currency could fall further, with more interest rate rises forecast, inflation yet to peak and government spending set to balloon as the new government attempts to tackle the cost-of-living crisis.

The pound isn’t the only currency to have lost ground against the US currency. This year, the U.S. dollar index, which compares the value of the dollar to the euro, yen, and other major currencies, has increased by more than 14%. The euro is at its lowest level against the dollar in two decades.

Why is the US dollar so much stronger?

Despite rising inflation, consumer spending has held up in the US, as the job market has remained steady. Importantly, the world’s largest economy seems less vulnerable than other major economies.

The UK, in contrast, has energy bills that are double where they were pre-pandemic, inflation is running at 10% and retail sales fell massively in August, having already fallen in July. While the Prime Minister and Chancellor will focus on easing the situation for both individuals and businesses, the fear is that this will only make the Bank of England’s job harder in reining in inflation, so rates will remain higher for longer, dampening growth.

But what does the pound’s weakness mean for your investments?

For UK-based investors, the strengthening of the dollar in recent months has helped mask underlying losses on both US and global equity funds. For example, while average fund in the IA North American sector has declined in capital terms by -19.6% since the start of the year, in pound terms the decline has been just -4.6% because gains made on the dollar has offset share price declines*.

Likewise, the IA Global sector has fallen by 23.2% on average in dollar terms, but only 8.9% when priced in sterling*.

When it comes to individual funds, the currency differential has meant negative returns have even been positive in some cases. For example, Murray International Investment Trust has fallen -7.3% year to date in dollar terms but risen just over 10% in sterling terms*.

Top performing Elite Rated US and Global equity funds in sterling terms

RankFund nameReturns year to date in US dollars*Returns year to date in Sterling*
1Murray International Investment Trust-7.30%10.01%
2JOHCM Global Opportunities-7.42%9.87%
3Lazard Global Equity Franchise-7.80%9.47%
4JP Morgan US Equity Income-7.90%9.30%
5M&G Global Dividend-14.46%1.51%
6Trojan Global Income-14.55%1.41%
7Guinness Global Equity Income-14.77%0.97%
8TM Redwheel Global Equity Income-14.94%0.94%
9Premier Miton US Opportunities-15.45%0.10%
10Schroder US Mid Cap-15.78%-0.05%

UK companies could also benefit from a strong dollar

Currency weakness is bad news in that it increases the cost of imports on goods or commodities like oil that are priced in dollars. It’s also bad for anyone planning a holiday in the US as their spending money won’t go as far.

But a cheaper pound also means our exports become cheaper and therefore more attractive to foreign buyers, and, because many of the companies in the UK stock market get their revenues from outside the UK – in particular larger companies – the strong dollar should help bolster profits and dividends despite issues in the domestic
economy.

Caution going forward

While sterling may fall further against the US dollar in short term, this trend won’t go on forever. A reversal may well be on the cards as and when the US central bank is seen to have stopped raising interest rates. At this point, the US dollar may lose some of its strength.

Likewise, if the Bank of England is seen to get on top of the inflation problem or data suggests that any recession may not be as bad a people fear, the pound could strengthen. If this is case, it could dampen returns for UK investors with money in US or global equity funds.

As always, having a diversified investment portfolio helps navigate the ups and downs of both equity and currency markets.

*Source: FE fundinfo, total returns in sterling and US dollars, 1 January to 21 September 2022

This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice. The content is not intended to be a personal recommendation to buy or sell any fund or trust, or to adopt a particular investment strategy. However, the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions. Past performance is not a reliable guide to future returns. Market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. Tax treatment depends of your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of any investment you should seek professional advice. Whilst FundCalibre provides product information, guidance and fund research we cannot know which of these products or funds, if any, are suitable for your particular circumstances and must leave that judgement to you. Before you make any investment decision, make sure you’re comfortable and fully understand the risks. Further information can be found on Elite Rated funds by simply clicking on the name highlighted in the article.