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Global Investing in 2013: Policy Dominance, Active Management, and a New Paradigm in Currencies

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An interview with Scott Mather, head of global portfolio management at PIMCO.

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Q: You mention currencies, what are the trends in currency markets?

A: We think currency is going to increasingly be used as a policy tool.

After the financial crisis, there was a lot of attention given to the expansion of central bank balance sheets as the banks pursued quantitative easing. Public concern seems to have faded; in fact, it is hardly discussed at all as many opponents have acquiesced for the time being. Meanwhile, central banks feel pressured to tackle unemployment, without much help from fiscal policymakers. Out of this mix we get QE policies that may either explicitly or implicitly weaken a nation's currency.

Switzerland was a dramatic example of this, explicitly targeting an exchange rate and pledging to print money to achieve it. This opened a new phase in monetary policy for the developed world. Now, other developed world central banks are explicitly using monetary policies to affect currency valuations.

Meanwhile, some emerging markets also are aggressively managing their currencies, and competitive currency devaluations have become much more likely, in our opinion. In the past, the carry trade, where a currency with low borrowing costs is traded for one that yields more, was a major factor for currency investors taking advantage of global interest rate differentials. But with so many nations near the zero bound, we believe carry is being overshadowed by many other factors.

Investors in the US or other countries running sizable deficits and debts amid modest economic performance (or worse) should be wary of currency devaluation as a byproduct of central bank actions. Yet consider that not all currencies can or will decline; active management and a well-thought-out global view are critical for navigating, and potentially capitalizing on, what some believe may become outright currency wars.

Q: Could you discuss the future of the US dollar? Do you believe it will continue to be the world's reserve currency?

A: Our forecast over a secular horizon (three to five years, or more) is that the US dollar will continue to be the primary reserve currency – but a less dominant one. In our opinion, there really is no reason why the world needs to have one hegemonic reserve currency, and increasingly the dollar is going to be rerated as its use as a store of value and medium of exchange diminishes. This process was bound to happen naturally over time, because as a share of world GDP the US is not as large as it used to be. But poor US debt dynamics, structurally weak growth and an aggressive monetary stance may accelerate the trend. Other economies are growing more quickly with less reliance on debt, and if investors were building a basket of currencies to store wealth, they would likely diversify and overweight currencies other than the dollar. Other developed world reserve currencies could undergo a similar reassessment.

Of course, the winners are ultimately countries with good growth and good balance sheets, including several emerging markets in Asia and Latin America. We believe this trend also favors slower growing but sound balance sheet countries such as Australia, Canada, and Scandinavian countries. We suggest investors consider diversifying into such currencies – it makes little sense to us to hold all of one's wealth in the US dollar, a currency we see losing value over the long term.

This article originally appeared on PIMCO.
No positions in stocks mentioned.
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