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Where to put your money now that the dollar is sinking

Where to put your money now that the dollar is sinking

Where to put your money now that the dollar is sinking

Republicans tripped up the U.S. dollar this week by failing to make progress on replacing Obamacare. This hurt the greenback by casting doubts on other reforms promised by President Donald Trump — including tax cuts and infrastructure spending.

Big picture, the GOP’s Obamacare setback is really only part of the problem for the dollar. Even if politicians miraculously get their act together (don’t hold your breath) the dollar is still in for trouble. In fact, it’s been weak all year for reasons that have little to do with Washington, D.C. — and those issues aren’t going away soon.

Indeed these challenges could bring a surprise breakdown in the dollar later this year, forcing investors to make some painful portfolio adjustments, says Jim Paulsen chief investment strategist at The Leuthold Group.

1: A global recovery is bidding up the value of other currencies

For most of the recovery since 2009, U.S. growth has outpaced foreign growth. That made the dollar more attractive. People had to buy it to get access to more favorable U.S. growth. Nowadays, though, about two thirds of foreign economies are growing faster than the U.S.

Europe is a good example. “The economy is growing well above its potential, and while full employment is still a ways off, it now seems very achievable,” says Mark Zandi, chief economist of Moody’s Analytics. Meanwhile, growth in China has stabilized, erasing fears about a potential meltdown there. And many emerging markets are back on track.

All of this means investment dollars are flowing out of U.S. assets into foreign countries. This, of course, puts downward pressure on the dollar and drives up foreign currencies. The trend is likely to persist. Leading economic indicators suggest foreign economies will continue to do well relative to the U.S.

2: Foreign bonds are becoming more attractive

For much of the recovery, U.S. government bond yields were more attractive than foreign bond yields. But now, as foreign economies strengthen, that’s changing. “For the first time in more than five years, foreign bond yields are finally becoming more competitive relative to U.S. yield offerings,” Paulsen says.

This, too, is channeling money out of the U.S. and into foreign countries, driving up their currencies relative to the dollar.

3: U.S. inflation will heat up

Many pundits think the greenback will hang in there because the Fed is hiking interest rates. This will entice foreign investors to buy dollars to get access to those higher yields, according to this theory.

But to really understand what is going on here and what it means for the dollar, you have to consider why the Fed is hiking rates. And that spells trouble for the dollar.

The Fed is raising rates because it sees signs of higher inflation. It wants raise rates to fulfill one of its two mandates — controlling inflation. To anyone owning dollars, inflation is bad news. It means they’ll have less purchasing power. So they naturally sell greenbacks. Indeed, history is replete with evidence that the dollar weakens when inflation rises. The best example: High inflation during the 1970s hammered the dollar.

Don’t make the mistake of being lulled by the June inflation slowdown. That was probably caused by one-off events. One was the sharp decline in cell-phone prices linked to the rising popularity of unlimited plans. Another was measurement problems related to changes in how doctors report their fees to government statisticians, Zandi says. “The Fed continues to downplay the recent drop in core inflation,” agrees Barclays economist Blerina Uruçi.

Leuthold’s Paulsen thinks tight labor markets will soon push wage inflation above 3%, and this will boost consumer prices as people buy more stuff. “We expect inflation anxieties to worsen in the second half of this year,” he says.

If inflation suppresses the dollar, as it normally does, matters will get worse. A weaker dollar bids up commodity prices. This leads to more inflation. And this erodes the dollar even more. Partly because of this feedback loop, a breakdown in the dollar could push wage and consumer price inflation to 3%-4%, says Paulsen, which would shock a lot of people.

A key factor to watch: Any move in the dollar below its current trading range. Since early 2015, the U.S. Dollar Index DXY, -0.29% , a measure of the dollar against a basket of foreign currencies, has traded in the 94-103 range. If it breaks out of that range to the downside, it will wake up a lot of investors to the potential for more dollar weakness. They’ll scramble to adjust their portfolios.

What to buy now:

Here’s what you can do now to benefit as investors make necessary changes to adapt to this new investing climate. Paulsen provided guidance on the themes below, and I’ve filled in suggestions on specific stocks and exchange traded funds.

1. Buy commodities: A weaker dollar pushes up commodity prices. So buying them now makes sense. Consider gaining exposure via PowerShares DB Commodity Index Tracking Fund DBC, -1.37% , or the US Commodity Index USCI, +0.10% Or for gold GCQ7, +0.76% exposure, iShares Gold Trust IAU, +0.92% or SPDR Gold Trust GLD, +0.86%

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Michael Brush

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