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Can Foreign Currencies Act as an Inflation Hedge?

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Inflation Hedge

Inflation Hedge

This infographic is available as a poster.

Can Foreign Currencies Act as an Inflation Hedge?

Inflation is like corrosion. Initially, it can make investment returns less attractive. Over time, it can significantly eat away at an investment’s value. For U.S. investors looking for an inflation hedge, holding foreign currencies may be one option.

But just how effective are they at managing inflation risk? In this Markets in a Minute chart from New York Life Investments, we look at how the performance of foreign currencies compared to U.S. inflation rates over the last four decades.

How to Hedge Against Inflation

Inflation reduces the value of a dollar over time. To manage this risk, investors look for returns that are higher than the inflation rate. For example, a currency that appreciates 6% during 2% inflation may be considered a relatively good inflation hedge.

What makes a currency appreciate? A currency will perform well against the U.S. dollar if investors consider the issuing economy to be strong. This is because foreign investors will look to purchase investments in the applicable currency, driving up its demand.

Foreign Currency Appreciation vs. U.S. Inflation

Here is how the four largest non-U.S. reserve currencies have performed from 1981-2020. We measured a foreign currency’s appreciation against the U.S. dollar using annual exchange rates. U.S. inflation was measured by the percentage change in the average consumer price index for all urban consumers. Neither metric was seasonally adjusted.

YearAverage U.S. InflationEuropean euroChinese yuanJapanese yenBritish pound
20201.2%1.9%0.1%2.1%0.5%
20191.8%-5.6%-4.5%1.3%-4.7%
20182.4%4.4%2.2%1.5%3.5%
20172.1%2.0%-1.8%-3.2%-5.2%
20161.3%-0.2%-5.7%10.2%-12.8%
20150.1%-19.8%-2.0%-14.5%-7.9%
20141.6%0.1%-0.2%-8.3%5.1%
20131.5%3.2%2.6%-22.3%-1.4%
20122.1%-8.3%2.4%-0.2%-1.2%
20113.1%4.8%4.5%9.2%3.7%
20101.6%-5.1%0.9%6.3%-1.4%
2009-0.3%-5.7%1.7%9.4%-18.4%
20083.8%6.9%8.7%12.2%-8.0%
20072.9%8.4%4.6%-1.3%7.9%
20063.2%0.9%2.7%-5.6%1.3%
20053.4%0.1%1.0%-1.8%-0.7%
20042.7%9.0%0.0%6.7%10.8%
20032.3%16.5%0.0%7.4%8.1%
20021.6%5.3%0.0%-3.0%4.2%
20012.8%-3.1%0.0%-12.8%-5.3%
20003.4%-15.4%0.0%5.2%-6.7%
19992.2%N/A0.3%13.2%-2.5%
19981.5%N/A0.2%-8.2%1.2%
19972.3%N/A0.2%-11.3%4.7%
19962.9%N/A0.4%-15.8%-1.1%
19952.8%N/A3.1%8.0%3.0%
19942.6%N/A-49.5%8.0%2.0%
19933.0%N/A-4.7%12.4%-17.6%
19923.0%N/A-3.5%5.8%-0.1%
19914.2%N/A-11.3%7.2%-0.9%
19905.4%N/A-27.2%-5.0%8.2%
19894.8%N/A-1.0%-7.7%-8.7%
19884.1%N/A0.0%11.4%7.9%
19873.6%N/A-7.8%14.1%10.5%
19861.9%N/A-17.6%29.4%11.6%
19853.5%N/A-26.3%-0.4%-3.0%
19844.4%N/A-17.6%0.0%-13.4%
19833.2%N/A-4.4%4.6%-15.3%
19826.2%N/A-11.0%-12.9%-15.8%
198110.4%N/A--2.7%-14.8%

Note: The euro was created in 1999, which is why annual appreciation data against the U.S. dollar is not applicable prior to 2000. The Chinese yuan / U.S. dollar foreign exchange rate was not available for 1980, which is why annual appreciation for 1981 is unavailable.

The Best and Worst Inflation Hedges, Historically

Based on available data, here is the percentage of time each currency’s annual appreciation was greater than the U.S. inflation rate.

European euroChinese yuanJapanese yenBritish pound
43%18%48%33%

The Japanese yen acted as the best inflation hedge, with its annual appreciation beating U.S. inflation 48% of the time. Demand for the safe haven currency has historically been strong for three main reasons:

  • After the Japanese banking crisis of the late 1990s, the government introduced a number of policy measures. This helped Japan enter the global financial crisis with a relatively stable banking system.
  • Japan is the largest creditor nation, meaning the value of foreign assets held by Japanese investors is higher than the value of Japanese assets owned by foreign investors. In times of market uncertainty, the money of Japanese investors tends to return home—driving up demand for the yen.
  • To take advantage of near-zero interest rates in Japan, investors conduct “carry trades” where they borrow funds in Japan and lend or invest in countries where returns are higher. During turbulent markets, investors may unwind these trades, furthering demand for the yen.

The Chinese yuan has been the worst inflation hedge, with the yuan’s appreciation beating U.S. inflation only 18% of the time since 1982. This is perhaps not surprising, given that the yuan was pegged against the U.S. dollar in 1994 to keep the yuan low and make China’s exports competitive.

In 2005, China moved to a “managed float” system where the price of the yuan is allowed to fluctuate in a narrow band relative to a basket of foreign currencies. This shift led to the yuan appreciating against the U.S. dollar in some years.

The Risks of Currency as an Inflation Hedge

As the chart makes clear, investing in foreign currencies can be very volatile. Not only can currency depreciation lead to losses, there are additional factors for investors to consider such as geopolitical risks.

Of course, the effectiveness of foreign currencies as an inflation hedge depends on their attractiveness relative to the U.S. dollar. If a country is also affected by the factors causing U.S. inflation—such as an increase in the money supply—its currency could be negatively affected.

Given the uncertainties associated with this strategy, investors may want to consider foreign currencies alongside other asset classes to help manage inflation risk.

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Markets in a Minute

The Projected Growth of Alternative Assets

Alternative assets — assets beyond stocks and bonds — are projected to grow by 62% from 2020-2025. Here’s which ones may grow the fastest.

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Alternative Assets

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The Projected Growth of Alternative Assets

When it comes to investing, the focus is typically on stocks and bonds. However, in recent years, many investors have turned their attention to another opportunity: alternative assets.

In fact, global assets under management (AUM) in alternatives are projected to grow by 62% from 2020-2025. In this Markets in a Minute from New York Life Investments, we explain what alternative assets are and which categories will see the most growth.

What are Alternative Assets?

Alternative assets are investments that fall outside of the traditional asset classes of stocks, bonds, and cash. They are broken up into the following asset classes:

  • Private equity: Investing in companies that are not publicly traded or listed on a stock exchange. This can also include the acquisition of public companies by a private investment fund or investor.
  • Private debt: Investing in companies in the form of debt as opposed to equity. Private debt is not typically financed by banks, nor traded or issued in an open market.
  • Hedge funds: Largely unregulated funds that can invest across a wide range of asset classes and instruments. These funds aim to ‘hedge’ risk and maximize profits regardless of which direction the market moves through long (buy) or short (sell) positions.
  • Real estate: The acquisition, financing, and ownership of real estate assets by private investment vehicles, funds, or firms. This includes residential, commercial, and industrial properties both at the time of original listing and when being sold between two parties afterwards.
  • Infrastructure: Investment in services and facilities considered essential to the economic development of a society. This includes energy, logistics, telecoms, transportation, utilities, and waste management.
  • Natural resources: Investment in the development, enhancement, or production of various types of natural resources. This includes agriculture, renewable energy, timberland, water, and metals.

In contrast to traditional markets, alternative assets are typically less liquid and less regulated.

Global Growth

According to Preqin, all alternative asset classes will see significant growth in global AUM. Here’s how the projections break down from 2020 to 2025:

 20202021P2022P2023P2024P2025PCAGR
Private equity4.4T$5.1T$5.9T$6.8T$7.9T$9.1T15.6%
Private debt$848B$945B$1.1T$1.2T$1.3T$1.5T11.4%
Hedge funds$3.6T$3.7T$3.8T$4.0T$4.1T$4.3T3.6%
Real estate$1.0T$1.1T$1.1T$1.2T$1.2T$1.2T3.4%
Infrastructure$639B$668B$697B$729B$761B$795B4.5%
Natural resources$211B$222B$233B$245B$258B$271B5.1%
Total$10.7T$11.7T$12.9T$14.1T$15.5T$17.2T9.8%

Private equity will grow the fastest, and will also see the highest growth in dollar terms. In fact, its proportion of alternative assets’ AUM is expected to rise from 41% in 2020 to 53% in 2025. Preqin predicts that this will be due to both strong performance and asset flows, with 79% of surveyed investors planning to increase their allocation to private equity.

Private debt is also expected to see strong growth. With greater risk appetite than banks, private debt funds could be active in emerging technologies such as pharmaceuticals and the remote working industry. These funds take on higher risk in anticipation of higher yield potential, an attractive proposition for investors amid low interest rates in many areas.

Similarly, investors will likely turn to real estate for its yield potential. Long-leased assets usually offer stable cash flows and indexed rents, making them one of the asset classes that may hedge inflation. However, the industry is projected to have the lowest compound annual growth rate, given the uncertainty facing office and retail spaces post COVID-19.

The Opportunities in Alternative Assets

Outside of investments such as liquid alternatives, alternative assets have typically only been accessible to institutional investors. However, recent regulatory changes by the U.S. Security and Exchange Commission (SEC) mean that private markets are opening up to individual investors if they meet certain criteria.

Alternative assets offer a number of compelling opportunities, including portfolio diversification, lower correlation with public markets, and potential outperformance. In fact, research has found that private equity was the best-performing asset class in a public pension portfolio, based on median annualized returns from 2010-2020.

According to Preqin’s projections, it appears investors are realizing this potential. While stocks and bonds will likely remain central to portfolios, alternative assets can help to broaden investors’ horizons.

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Markets in a Minute

The Recovering Financial Health of Americans

The economic recovery has not been even. We show the increase in Americans’ financial health by race, income, gender, and location.

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Financial Health

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The Recovering Financial Health of Americans

Did you spend less and save more due to the COVID-19 pandemic? If so, you’re not alone.

Overall, the percent of Americans with strong financial health increased by 2% from 2020-2021. This was largely due to the aforementioned behavioral changes, along with government interventions like stimulus payments that helped Americans pay off their debt.

However, the economic recovery has not been even for everyone. This Markets in a Minute from New York Life Investments looks at which Americans have seen the biggest increase in their financial health, broken down by race, household income, gender, and location.

What is Financial Health?

Before we dive into the results, let’s take a look at what financial health means. It is measured using eight indicators within four broad categories:

  • Spend: Spend less than income and pay bills on time
  • Save: Have sufficient liquid savings and long-term savings
  • Borrow: Have manageable debt and a prime credit score
  • Plan: Have appropriate insurance and plan ahead financially

People are considered to be financially healthy when they have strong scores across all of the above indicators.

Changes in Financial Health

In order to measure financial health, the Financial Health Network surveyed 6,403 respondents in April and May 2021. Below are the changes in financially healthy people, measured in percentage points (p.p.), from 2020-2021. Statistically significant responses, where the authors are 95% confident that the observed results are real and not an error caused by randomness, are marked with an asterisk.

GroupChange in Financially Healthy People (2020-2021)
Overall2 p.p*
Black9 p.p.*
Latinx4 p.p.*
Asian American11 p.p.*
White0 p.p.
< $30,000 Household income2 p.p.*
$30,000 - $59,999 Household income2 p.p.
$60,000 - $99,999 Household income2 p.p.
> $100,000 Household income1 p.p.
Men4 p.p.*
Women1 p.p.
Northeast2 p.p.
Midwest3 p.p.
South5 p.p.*
West-1 p.p.

With an 11 percentage point jump, Asian Americans saw the biggest increase and are now the most financially healthy of any race. The increase was due to an absence in major employment disruptions, growth in employment, and generous unemployment benefits for those who did experience disruptions.

In addition, the proportion of Black people considered financially healthy nearly doubled due to two primary factors: receipt of stimulus payments and reduced spending. This helped Black families to build up savings, pay bills on time, and improve their credit scores.

While men experienced an increase in financial health, women were disproportionately affected by employment disruptions and childcare responsibilities. For instance, women were more than twice as likely as men not to work due to childcare responsibilities in 2021. Meanwhile, men reported bigger improvements in their liquid and long-term savings than women.

People with a household income under $30,000 saw slight improvements in their financial health, primarily due to unemployment benefits and reduced spending. However, lower-income households saw a significant reduction in the “planning ahead financially” indicator, signifying this could be a temporary improvement.

A Current Snapshot

While it is primarily marginalized groups that saw the biggest improvements over the last year, large gaps in financial health remain. Here is the current percentage of people who are financially healthy for each group.

Financial Health

The starkest differences are by income level. People with a household income under $30,000 are nearly five times less likely to be financially healthy than those who have a household income over $100,000.

However, gaps occur across race, gender, and location as well:

  • The proportion of Black and Latinx people who are financially healthy is significantly lower than that of Asian Americans and White people.
  • Despite an increase in female breadwinners in recent years, women are much less likely than men to have strong financial health.
  • Of all regions, Americans living in the South are the least likely to be financially healthy.

At an aggregate level, only one-third of Americans are considered to be financially healthy.

A Continued Recovery?

While it appears that government relief efforts have helped traditionally marginalized groups, it remains unclear what will happen now that these programs are winding down. Not only that, large gaps in financial health still exist. The Financial Health Network recommends policies tailored to help close these gaps, such as universal child care and policies that reduce the disparities in educational opportunity.

Of course, government programs, macroeconomic conditions, and individual behaviors will all play a role in Americans’ financial health going forward. If you were fortunate enough to spend less during the pandemic, do you plan to continue saving more? Your actions could help you build a solid foundation to manage expenses, while also planning ahead for long-term needs.

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