- Speculation abounds as to why the dollar is rallying.
- Like stocks, currency movement is ultimately the result of supply and demand.
- Regardless, long-term investors with a globally diversified portfolio needn't fret over daily currency moves.
What do the Russian-Georgian conflict, a drop in oil prices, a rise in consumer prices, and central banking expectations have in common? They're all mentioned as reasons behind the dollar's recent rally.
So which theory is right? In reality, all of these could have some impact on the dollar. But ultimately, what drives the dollar's relative strength is supply and demand.
Currencies are rather like stocks—in the near term supply is relatively fixed. Long-term, central banks can issue or suck in as much money as they want. But near-term, currency wiggles are dictated by sentiment. And sentiment is fickle. People suddenly see the US as a safe haven in a world gone mad? Sure, that could cause a dollar rally. Folks suddenly banking on the US having higher interest rates later on? Fears commodities could tank? These can impact sentiment short term. But so can any silly thing. Sentiment is fleeting and you can't know how much impact any of these will have on dollar's future direction. Nor is there any evidence that long-term, there's a meaningful correlation between geopolitics, oil, inflation, gold medal count, etc. and the dollar's relative standing.
Maybe the dollar has bottomed. If that's the case, we can almost guarantee there will be as many people bemoaning a strengthening dollar as there were over the weak dollar. A strong dollar has benefits and drawbacks, as does a weak dollar. Neither is inherently better. Or maybe the recent rally is short-lived and the dollar will remain weak for an extended period—nobody knows for sure.
The question you should ask is, "Does it matter?" The answer: Not really.
Currencies are merely different flavors of money. Sometimes a weak dollar makes your foreign returns look better, sometimes the reverse. But there's no predictable pattern, and in the long run, the currency effect on a global portfolio is almost nil. Sure, if you short-term trade currencies, currency volatility matters. But if you're timing currencies, you better have the world's best crystal ball or a pile of cash to burn.
So what should you do in light of the currency hubbub? A good way to mitigate the effects of currency fluctuations is simply own a globally diversified portfolio. Because currency movements are zero-sum (one goes up, another goes down equally), the affects of a weak or strong currency gets offset over time. Fearing a strengthening dollar is about as fruitful as fearing a weaker dollar. A well-diversified global portfolio negates the need for either reaction.