Pimco's Gupta Goes With Gut on FX as `Rich' Dollar Defies Models

(Bloomberg) -- Pacific Investment Management Co.’s Sachin Gupta is of two minds when it comes to the greenback.

By many conventional measures, the dollar is too pricey. International Monetary Fund data show the currency is trading almost 13 percent above its 10-year average in real effective terms as of December, while the Federal Reserve’s trade-weighted dollar index has climbed to within 3 percent of its 2002 record high.

That valuation would typically lead Gupta to underweight the currency across his global bond portfolios. However, he’s not quite ready to call time on the dollar’s recent rally. Swirling uncertainties about the U.S.-China trade relationship and a darkening global-growth outlook could support the already “rich” greenback in the months ahead, according to Gupta. So for the time being, he’s keeping his exposure to the currency neutral.

“If you’re neutral something, by definition your expectations of returns on that asset are noise-zone, as opposed to a definite ‘This is going up or down,”’ said Gupta, who’s based in Newport Beach, California. “We’re not trying to take views for 1-to-2 percent moves.”

The Bloomberg Dollar Spot Index climbed about 3 percent in 2018, gaining against most of its Group-of-10 peers and upending bearish Wall Street forecasts. The greenback’s showing signs of strength in 2019 as well, logging its longest winning streak since 2016 this month. It advanced Wednesday on hints that U.S. core inflation could be picking up, and was little changed Thursday despite a report showing retail sales slumped in December.

Haven Force

Though Pimco’s valuation-based models signal that the currency is expensive, Gupta says its haven characteristics could portend more strength ahead. The U.S.-China trade relationship remains tense ahead of a March 1 deadline for the U.S. to escalate tariffs on $200 billion worth of Chinese goods. U.S. President Donald Trump is considering pushing back the deadline by 60 days as the two sides try to negotiate a solution, according to people familiar with the matter.

Whether the world’s two largest economies are able to reach an agreement will be key in determining the dollar’s direction, Gupta said. A truce would buoy risk sentiment and likely see the greenback “weaken across the board,” he said. However, a further fraying of the relationship could send investors searching for safety in the U.S. currency.

“If it looks like there’s no deal and we go back to the possibility of further trade escalations, that’s going to be pretty bad for global growth and the dollar could rally more,” said Gupta. He co-manages Pimco’s $10.2 billion International Bond Fund, a dollar-hedged fund that’s outperformed 92 percent of its peers in the past year, data compiled by Bloomberg show.

Weakness Elsewhere

The outlook for the global economy is also giving Gupta pause. Weak data from China have markets worried about the spillover effects from a Chinese slowdown, while sputtering European growth saw the euro fall this week to its lowest since November.

“The weakness in economies outside of the U.S. seems to be more problematic, perhaps more likely to persist” than recent signs of cooling U.S. growth, according to Gupta.

Despite the gloom, there’s value to be found in emerging markets, Gupta said. The dollar looks costliest versus developing-nation currencies, leading Gupta to add overweight positions in the Mexican peso, Russian ruble, Colombian peso and Indonesian rupiah.

Regardless, given that the dollar is such an “important starting point” in constructing a portfolio, he has broadly cut foreign-exchange exposure in the past few months. Amid all the competing forces buffeting the dollar, his level of currency risk is probably in the “bottom quartile” compared with the past decade.

“When the European Central Bank and Bank of Japan had launched quantitative easing and were in the process of aggressively easing policy, we had a much stronger conviction on currencies,” Gupta said. “These days, it’s a much smaller risk allocation. That’s primarily because we don’t have a strong view on the dollar.”

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