Currency Impact Report
FX Impact: Euro Rise Helps US Investors
July 30, 2012
The euro continued its up-and-down movement against the dollar last week, only this time it strengthened on renewed hopes eurozone policymakers would finally take steps to stem the crisis that has spread from Greece to Spain.
IndexUniverse ETF Analyst Ugo Egbunike said that while the European Central Bank’s words reassured nervous markets and boosted returns for U.S. investors, the ECB’s words didn’t include much in terms of specifics, meaning the crisis is far from over and the currency may well continue its longer-term weakening trend.
Surveying currency crosses around the world, Egbunike told IndexUniverse Correspondent Cinthia Murphy that the Brazilian real also strengthened against the dollar last week, but stressed that its weakness has left U.S. investors with losses of 18 percent while local investors have experienced gains of 5 percent.
Murphy: Are foreign exchange rates something that most investors take into account when they look at a benchmark’s performance and anticipate the total returns on their investment?
Egbunike: A lot of people don’t even think about this. But they should. When a U.S. investor wants to invest in, say, the U.K., he or she has to take dollars and convert them into pounds in order to buy U.K. stocks. That means that when the pound appreciates relative to the dollar, the investor could have an added return vs. gains of local investors who are linked to that same benchmark and who have not benefitted from the conversion back into dollars. That currency component is an investment in and of itself.
Murphy: This week all attention was still focused on Europe. So let’s look first at the euro.
Egbunike: Yes. This week was all about the euro strengthening against the dollar on strong optimism that the European central bank is ready to act more as a central bank now and buy sovereign bonds in the secondary and primary markets to help save the euro. We have yet to see a plan or any details of how they will go about it, but the optimism was enough to send the euro higher relative to the dollar.
Murphy: How high are we talking about?
Egbunike: In this past Sunday-to-Sunday period, the euro gained 1.45 percent vs. the dollar; it hit 1.22 per U.S. dollar. It hasn’t been this high since early July. That move means that U.S. investors invested in Europe saw this week an enhanced return of 1.45 percent on their investment from the currency exchange alone. But if you look at year-to-date performance, the euro is still very close to its lowest reading since the beginning of the year, and in the past 12 months, the euro has accounted for -10 percent to -20 percent in returns to U.S. investors.
Murphy: Is this upward momentum sustainable, then?
Egbunike: We should expect more back and forth action until we see a comprehensive plan put into place to deal with the debt crisis in Europe. If you think about it, this is the first time the euro has had a crisis like this, so everything that they are doing is setting precedents for future action—there hasn’t been a comprehensive package for a crisis like this before from which to draw measures and ideas. They are in a way kicking the can down the road, so we’ll be going back forth until the market just gets tired of it.
Murphy: Aside from the euro, what else is catching your eye out there?
Egbunike: In Brazil, the real appreciated against the dollar this week, so U.S. investors had a currency-added return of 0.4 percent on Brazilian equities this week. But if you look at the past 12 months, Brazil has been one of the worst fx crosses for U.S. investors. While a local investor has gained 5 percent on the real-dollar exchange rate in the past year, U.S. investors have lost 18 percent, and the full impact of the exchange rate on U.S. investor-owned portfolios of Brazilian securities was more than 23 percent in the past 12 months.
Murphy: What gives in Brazil?
Egbunike: The Brazilian real started to depreciate as the local central bank printed more money, and that depreciation led a lot of people to run to the U.S. dollar as a safe haven, which just made matters worse. But it’s really a mixture of how the country is reacting to the global economy—and its problems—and of a slowdown in foreign investment inflows, which cooled down the currency.
Murphy: If countries like Brazil and South Africa are not delivering, where are investors finding the currency-linked returns today?
Egbunike: The Philippines are very interesting. If you look at the past 12 months, U.S. investors have seen their returns on Philippines exposure enhanced by something like 17.6 percent. That strength in their local currency is only because countries like Brazil aren’t doing so well, so more and more people are coming into the Philippines. It’s a frontier market that has gotten itself on the road, it doesn’t have that bad corruption, and there’s a lot of optimism about its economy. The BRICS have been hot for so long, people are now looking for who else is hot.