What Fed Action Would Mean for the Dollar

Last week the Fed hinted at more possible stimulus, which caused the dollar to drop. While it still remains unclear how or when the Fed may act, investing experts suggest dialing back on the dollar and consider currencies and commodities that would benefit if the dollar dropped in value.

By Jonnelle Marte
Aug 22, 2012, 6:05 PM
Smart Money

When the Federal Reserve hinted Wednesday more stimulus could be on the way, the dollar sunk. While it remains unclear how or when the Fed might act, investing pros say it may still make sense to dial back on the greenback.

Minutes released from the Fed’s latest meeting noted that more officials feel monetary action would be needed “fairly soon” without signs of “a substantial and sustainable strengthening in the pace of the economic recovery.” Fed officials discussed launching another bond-buying program, extending their guidance on how long interest rates could stay near zero, and lowering the rate the Fed pays banks for reserves, according to the minutes.

Advisers say each of those efforts could potentially lead to a weaker dollar — albeit to different extents. But some pros say that even if the Fed doesn’t act, the dollar could still lose ground against the euro and other currencies in coming months and years. Certain foreign currencies should do well, whether “the Fed says they’re going to stimulate the economy or not,” says Chris Gaffney, senior vice president of EverBank World Markets.

Investors might consider balancing their domestic exposure with a stake in currencies and commodities that would benefit if the dollar dropped in value. Rick Scott, chief investment officer at L&S Advisors in Los Angeles, says he invests up to 10% of a client’s portfolio in gold, which tends to rise in price when investors worry about inflation, by using an exchange-traded fund like the $9.8 billion iShares Gold Trust (IAU). Some investors may also want to buy ETFs that invest in crude oil, which generally gains when the dollar depreciates, he says.

When Ben Bernanke speaks in Jackson Hole at the annual symposium of economists and policymakers next Friday, investors may get more clarity on where the Fed is headed. But many pros say any possible action is more likely to be announced at the Fed ’s next regular meeting on Sept. 12 and 13. By then, Fed officials will have more information to help them make a decision, including another monthly unemployment report.

To be sure, some experts — including Fed officials — doubt that further bond buying by the Fed will lift the economy. Banks are still hesitant to lend to consumers, a trend that is keeping a lid on the housing market and retail spending, advisers say. Others argue that any action from the Fed would also have a minimal impact on markets, since many investors who have been counting on additional stimulus already pushed stocks higher and the dollar lower.

And regardless of whether the Fed acts, investors should expect to see more volatility in currency markets, says Alfonso Esparza, a currency analyst with trading platform Oanda. That is partly why Paul Christopher, chief international strategist for Wells Fargo Advisors, recommends a more balanced approach between defensive and cyclical currencies and commodities. Christopher is splitting his commodity allocations between gold, which should outperform when investors are being cautious, and energy stocks, which should gain if economic activity picks up. When it comes to currencies from developed countries, he is dividing his investments between the Japanese yen, a safe haven currency, and the Norwegian krone, which should benefit if oil prices rise.

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