For many years, the USD has been weakening against the SGD. When I made my first trip to the US in 2002, the exchange rate was above 1.70. Today, it hovers around 1.30. This downtrend weighs among the concerns of Singaporeans who want to invest in the US markets but are worried that the USD will continue to fall. Many questions arise. Is the USD a weak currency? Is investing in the US markets still sensible in light of a declining dollar? Should we avoid periods where the US central banks are cutting rates? Can we hedge away the currency risk? Will the US and the dollar collapse on the weight of its growing debt and the de-dollarization trend?
These reservations are understandable and not new. Let’s address them from a practical standpoint.
1. Is the USD a weak currency?
When we talk about a currency’s strength or weakness, it is always relative to another currency or a basket of other currencies. In the case of the USD, the short answer is no. It is not what one would consider a weak currency. In fact, over the past 20 years, it has appreciated against many of its developed market peers including the Euro, Pound, Yen, Aussie, and Canadian dollar. Therefore, it is not that the USD is weak but rather the SGD is strong.
As Singaporeans, we are very fortunate to live in a country with one of the strongest and most resilient currencies in the world. Backed by large current account surpluses and deep foreign reserves, the Monetary Authority of Singapore (MAS) manages the SGD within a band against a basket of currencies from our major trading partners. This helps to control inflation and stabilize our economy.
However, this strength poses challenges for those looking to diversify their investments beyond Singapore’s borders. This isn’t a situation unique to US investments; when foreign currencies weaken against the SGD, the returns on overseas investments can be eroded. A quick look at the SGD’s performance over the past one or two decades reveals that most currencies, including those of many developed and Asian nations, have depreciated against it. The only notable exception is Switzerland’s Swiss franc (CHF).
2. Is investing in the US markets still sensible?
Currency risk is an inherent part of international investing. While a weakening currency can reduce returns, what ultimately matters is the long-term performance of the investments. The key question is: do the numbers still hold up after accounting for currency movements? If the underlying investments remain strong, temporary fluctuations in exchange rates may have a limited impact on the overall outcome.
To get a better sense, let’s see how the stock markets of other countries stack up against Singapore over the past 20 years. We calculated their annualized returns using MSCI regional and country net indices, which account for the reinvestment of dividends. To ensure comparability, we display their returns both in local currency and USD terms side by side.
Despite the depreciation of these countries' currencies against the SGD over the same period—some significantly—many still delivered respectable returns. Almost half outperformed the Singapore stock market when measured using USD as the common currency. The US stock market also still ranks among the top performers with an annualized return of 10.1% against Singapore’s 7.2%. This suggests that even with headwinds from currency fluctuations, strong underlying market fundamentals can still drive robust investment returns.
3. Do the Federal Reserve rate cuts lead to the USD depreciating even more?
Many people associate a rate-cutting cycle with the corresponding weakening of the USD against other currencies. The assumption is that lower interest rates generally make a currency less attractive to foreign investors. However, this relationship is not always so clear-cut. There are other factors that can shape how the USD moves, and in some cases, the dollar may even strengthen despite lower interest rates.
For instance, the USD holds a unique position as the world’s primary reserve currency and is often considered a safe haven. In times of global crisis, the US may see heightened capital inflows as investors seek the safety and liquidity of US assets, in particular Treasuries. This can prop up the dollar. The state of other countries’ economies, monetary stance, interest rate expectations, and investor sentiments are also key factors in driving currency movements. With currencies, things are always relative. If their situation is worse off or their central banks are even more dovish than the US Federal Reserve, then the USD may also appreciate instead.
Historical data tracking the US interest rate cycles and the corresponding move on USDSGD also suggests that US rate changes alone do not dictate the direction of where USDSGD is headed. Cutting rates does not always lead to a fall of the USD against the SGD. There are exceptions. Neither does hiking rates consistently lead to the dollar appreciating. In fact, across all the hiking episodes observed, the USD fell against SGD.
4. Can we hedge away the currency risk?
Yes, there are various ways to implement a currency hedge. You can hedge your currency risk using spot FX, forward contracts, futures, swaps, or options. However, hedges are not perfect and have to be actively managed. There are also costs involved which can be substantial.
As the USD interest rates are higher than SGD rates, you will need to pay the difference to maintain the hedge. This is also known as the cost of carry which can fluctuate from time to time. As of October 2024, this cost is estimated to be around 2% per year. In addition, brokers will apply a markup. If the markup is 1%, then the total cost to hold the hedge becomes 3% per year. And these exclude other transaction fees that brokers may charge for execution.
How much we actually end up paying in practice will depend on whether we are implementing a full hedge or a partial hedge, and whether we deploy the hedge tactically or have it in place all the time. To put things in perspective, for the past 20 years, the depreciation of USD vs SGD per year is only 1.35%. Thus, the bigger question is whether we can effectively manage the hedge such that the benefits outweigh the costs over the long term.
Hedged vs. Unhedged Fund Performance
The table above shows a hedged and unhedged share class of a fund that invests principally in US equity securities. During these periods, the USD declined against the SGD. On an annualized basis, the hedged version did better over shorter periods up till the past 5 years. However, it underperformed over a 10-year period. This underperformance of the hedged share class over the long term is likely and largely due to the costs associated with maintaining the hedge, which exceeded the currency’s depreciation. Hence, even though hedging can protect against short-term currency fluctuations, the long-term costs may surpass the benefits it brings about.
Instead of directly hedging against the currency risk, a diversified portfolio with exposure to gold, and other commodities can also offer some protection against adverse USD movements as these assets tend to be inversely correlated with the strength of the dollar.
5. Will the US and the dollar collapse on the weight of its growing debt and the de-dollarization trend?
The dominance of the dollar has continually been questioned especially in recent years as US debt rose to new heights with some countries looking to shift away from the reliance of using the dollar for trades. While US’s influence might wane in the future, it is likely going to remain one of the strongest nations in the world. A collapse of the USD is also unlikely to happen particularly in the near term. As it is today, USD still plays a massively significant role across international trade, financial markets, and global reserves.
(A) USD is still the dominant reserve currency
As of Q1 2024, the USD still accounts for 59% of the reserve currencies held by central banks worldwide. Even though that has come down from more than 70% in the 1960s, it remains the overwhelming majority, with the next closest contender, Euro, at a distant 20%. China’s renminbi, while gaining attention, still faces significant challenges and only represents 2% of the global reserves.
(B) USD is the most liquid and heavily transacted currency in the Global FX market
The USD continues to be the backbone of the global FX market, taking a side across all 7 major currency pairs in the forex market: EURUSD, USDJPY, GBPUSD, USDCHF, AUDUSD, USDCAD, and NZDUSD and is involved in nearly 90% of all global FX transactions.
(C) USD is deeply entrenched in international trade and settlement
The USD stays deeply entrenched in the global trade system. Almost half of all international invoices and 40% of the SWIFT messages are denominated in USD. This underscores the central role the dollar plays in global commerce, reinforcing its status as the world’s preferred currency for international settlements.
(D) USD is the most heavily used global funding currency
More than half the international debt and cross-border loans are denominated in USD. Corporations, banks, and governments worldwide frequently issue debts in USD, even if they are not based in the U.S. This creates a deep pool of USD-denominated securities that are integral to the functioning of global capital markets.
(E) An imminent collapse of the USD and the US being unable to service its debt is unlikely
The speed at which the US national debt is rising is a growing concern. Public debt, which is debt held by investors, financial institutions, and foreign governments, stands at $28.31 trillion in 2024 (source: fiscaldata.treasury.gov). This is nearly equivalent to the size of the US GDP, a cumulative result arising from years of budget deficits where government spending consistently exceeds revenue. With an aging population, rising healthcare costs, and increasing social security commitments, the fiscal gap is expected to widen in the years ahead. If left unchecked, the burdens of growing liabilities will exact a toll on the US economy, curtail its ability to borrow further and limit resources to fund its programs and implement monetary policies.
The US’s dominance and unique status have allowed it to have an extraordinary capacity to carry higher burdens of debt. But the question is at what level would the debt become unsustainable leading to a US default and how long would it take to reach there? There are no outright answers. Findings from studies differ and are far from straightforward. Wharton’s budget model (source: Penn Wharton University of Pennsylvania) predicts that US public debt cannot exceed 200% of the GDP and that the US has about 20 years for corrective action. Goldman Sachs think the US is unlikely to breach the thresholds in the next 25 years. The US Congressional Budget Office (CBO), on the other hand, does not think an upper threshold can be identified that would make a crisis imminent ((source: Goldman Sachs Asset Management).
But ultimately these are just projections where many assumptions will need to hold. Will the US government sit facing these issues and do nothing for the next 25 years? And even if these levels materialized, does it imply that the US or USD will collapse? Japan’s debt is 228% of its GDP and even though the bulk of its debt is domestically owned, they do not hold the special status that the US enjoys. Yet, they have managed to avoid a crisis. And given that all the debt the US holds is denominated in its own currency, it is quite inconceivable for them to be unable to service their debt, though that might come at a cost to the value of the dollar.
It is hard to predict what can happen in 25 years' time. But most will agree that a collapse of the US economy and the dollar in the near time is far from likely. And chances are, even if the influence of US wanes in the long term, it is still likely to remain among the strongest nations in the world.
Conclusion: The US market can form a key component of a diversified portfolio
While concerns about the long-term decline of the USD against SGD are understandable, it should not deter investors from investing in the US markets. The US is still one of the strongest and most resilient economies that historically delivered good returns outperforming many of its peers.
Currency fluctuations are part and parcel of international investing. While it can be a drag to the returns in the short term, the long-term benefits of a well-calibrated and diversified portfolio outweigh the risks. Within the US markets, investors can also gain exposure to areas that may not be as accessible in local or regional markets such as leading technology companies and global healthcare giants. With the right strategies, US assets are still invaluable in enhancing the overall resilience and growth potential of your portfolio.
Disclaimer:
The information provided in this blog post is for educational and informational purposes only and should not be construed as financial or investment advice. The strategies and examples discussed are based on past market conditions and may not be suitable for all investors. In preparing this note or post, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was otherwise reviewed by us. While the information provided herein is believed to be reliable, AllQuant makes no representation or warranty whether expressed or implied, and accepts no responsibility for its completeness, accuracy, or reliability. Investing involves risks, including the potential loss of principal. The performance of any investment strategy is not guaranteed, and past performance is not indicative of future results. Always consult with a qualified financial advisor or professional before making any investment decisions. AllQuant is not responsible for any financial losses that may arise from the implementation of strategies or ideas discussed in this post.