Economy & Markets
1 minute read
In a year in which political uncertainty and macroeconomic risks have dominated the rhetoric, Latin American currencies have experienced an astonishing average increase of 5.8%1. How can low economic growth be reconciled with stronger exchange rates?
The reality is that this is not Latin America’s merit, as much as the EUR’s +8.6% year-to-date appreciation is not entirely attributable to improving prospects for European growth. Stronger international currencies are mostly responding to the weakness of the U.S. dollar, an obvious consequence of the U.S. government’s erratic trade policy.
However, regardless of current movements, currency diversification is always a prudent strategy, regardless of local currency exchange rates. Currency diversification not only helps mitigate the risk associated with concentration in a single currency, but also provides access to investment opportunities in different markets. By spreading assets across multiple currencies, investors can hedge against the volatility and economic fluctuations that affect local currencies. In addition, a diversified portfolio allows one to take advantage of the strengths of foreign economies, which may be in different phases of the economic cycle, thus providing long-term balance and stability.
While the rest of the world's sales to the United States account for just 4% of their combined GDP, U.S. exports to the same destinations are equivalent to 11% of national GDP. In its confrontation with the world, the United States has the most at stake.
After years of exceptionalism in U.S. economic growth, so far in 2025, economists have cut their forecasts for the United States more than for any other region.
Adding to weakening prospects, cost of capital in the U.S. keeps rising as investors demand a higher “term premium” on the back of tariff-related uncertainty and persistently higher U.S. deficits. So far, the deficit has been largely financed by foreign ownership of U.S. assets, currently standing at approximately $26 trillion.
Even minor shifts in portfolio allocations or currency-hedging decisions can have significant impacts. For instance, a 1% change in hedging could lead to over $160 billion in U.S. dollar selling. An example of this is the Taiwanese dollar, which appreciated nearly 8% in two trading days as local exporters and life insurance companies rushed to convert or hedge their large USD holdings, leading many to question the sustainability of the role of the USD as the world’s reserve currency. We disagree.
While we believe there is room for further underperformance on the back of a cyclical convergence and global re-allocation of assets, no other currency rivals the USD’s role in global reserves, trade settlement, or financial infrastructure. It accounts for about 90% of FX transactions, 66% of international debt, 58% of foreign exchange reserves, and 48% of SWIFT (Society for Worldwide Interbank Financial Telecommunication) transactions.
For many of our clients in Latin America, currency diversification comes naturally, given the source of their wealth and the exposure they already have to their local currencies. As such, they hold most of their financial assets outside of their home countries in USD. When talking about diversifying currencies, it does not mean increasing concentration to local currencies. In fact, further concentrating locally would expose many to higher volatility and excess concentration of idiosyncratic risks, especially this year when we expect significantly lower growth across all countries (ex. Argentina) and further monetary easing, lowering the attractiveness of local yields.
As our Head of Global FX Strategy, Sam Zief, mentioned in our latest piece: "Dollar Diversification: Why Now?", there is no perfect way to go about diversifying currency exposure. However, a reasonable benchmark for reference is the non-U.S. exposure in the MSCI World, which stands at ~25%.
Gold also stands out as a reliable asset, particularly in times of dollar weakness. Its appeal as a physical store of value has grown amid geopolitical tensions, with central banks, notably in emerging markets like China, increasing their gold reserves. For individual investors though, the metal’s nature as a non-yielding asset means that considering the importance of income in a portfolio is crucial when deciding upon an appropriate allocation.
A diversified portfolio might offer greater stability and predictability over the long term. By balancing exposure to different currencies and regions, investors could achieve a more consistent performance and reduce the impact of currency volatility. By maintaining a diversified portfolio, investors can reduce the risk of significant losses due to currency fluctuations or economic downturns. This stability can provide peace of mind and allow investors to focus on achieving their financial goals without being overly concerned about short-term market volatility. Long-term stability is crucial for investors seeking to preserve and grow their wealth over time.
In an increasingly interconnected world, investors may benefit from reflecting on their currency exposure and diversification strategies. By understanding the potential risks associated with local currency concentration and considering a global approach, investors might better position themselves for long-term success.
Reach out to your JPMorgan team now to discuss what this means for your portfolio and long-term financial goals.
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