Pressure on the Dollar

Looking for growth in today's market? Despite the huge bull markets in emerging markets and in commodities, there's still time to buy.

A lot of smart people continue to say that. For a different perspective, I turned to the best bond managers I could find: Dan Fuss and Kathleen Gaffney, co-managers of Loomis Sayles Bond (LSBDX).

Surprise. They're saying the same thing. They add another important prediction: Beware the dollar. Although the greenback has looked downright plucky against other currencies the past year or so, it's due for another big spill -- especially against currencies in fast-growing emerging markets.

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The fund's great record leads me to think Fuss and Gaffney are probably right. Loomis Sayles Bond has returned an annualized 12% since inception in late 1991. Over the past ten years, the fund is number one among mostly-corporate bond funds.

"We expect another move down for the dollar," Gaffney says. She says the dollar may well fall 15%, especially against Asian currencies.

Loomis Sayles Bond currently has about 40% of assets in foreign currencies. Fuss and Gaffney aren't anticipating much growth in Europe or in most of the developing world, except those countries with lots of commodities. So half of their foreign exposure is in commodity-rich Canada, and the remainder is in emerging markets. In Latin America, they like Brazil and Mexico.

In Asia, they're buying currencies that will do well when China turns serious about raising the value of its currency, the yuan. That's a good bet, says Gaffney. "China is focused on becoming more of a consumption-based economy, and to do that they'll need a stronger yuan to pay for imports."

Despite the huge U.S. trade gap, the dollar has remained strong because interest rates are higher here than in most countries. But now rates around the globe, except for Japan, are converging, Gaffney says. That means currencies will trade more on the fundamentals of their economies.

In the U.S., she expects the Fed to raise short-term rates (currently 4.5%) to 5%, perhaps even 5.25%. She thinks the yield curve will truly invert -- in other words, long-term bonds will yield less than short-term bonds. Although historically that has often meant a recession, she sees the U.S. economy as too strong for that to happen.

The recent rise in the yield of the ten-year Treasury, Gaffney says, "is a blip that represents a buying opportunity." Fuss and Gaffney believe long-term rates will move up over the next ten years -- in contrast with the past ten years. But they don't see long-term rates rising much in the next year or so. Keeping long-term U.S. rates below 5% or so for now, Gaffney says, will be continued buying by Asians eager to invest all the dollars the U.S. spends in Asia.

How to invest if you buy into Fuss and Gaffney's forecast? One obvious way is to buy their fund. Although quite volatile, it has almost always proven worth the ride. It's perfect for the aggressive part of your bond investments.

But upping your investment in foreign stocks and bonds a bit would be another way to follow their forecast. A solid emerging-markets fund such as SSGA Emerging Markets (SSEMX) or an Asia fund such as Matthews Pacific Tiger (MAPTX) would do the trick. Or consider a commodity fund such as RS Global Natural Resources (RSNRX) or T. Rowe Price New Era (PRNEX).

Opinions expressed in this column are those of the author.