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Luc de la Durantaye, chief investment strategist and CIO, CIBC Asset Management.
We’re exploring, certainly from a longer-term perspective, an important peak in the U.S. dollar that remains to be continued and watched. But certainly from a cyclical perspective as well, we have a certain degree of pessimism around the U.S. dollar. It’s predicated on a number of elements that we have talked about in the past. One is, especially following the pandemic, the U.S. dollar’s rally has brought the U.S. dollar into a fairly expensive level on a broad-based perspective — not only just against Canadian dollar but against a basket of foreign currency. So, that’s point number one.
Point number two: the U.S. central bank has lowered interest rates. The U.S. used to have an interest rate advantage over many countries. With the Federal Reserve lowering interest rates, the relative interest rate is no longer supporting the U.S. dollar. That’s another point.
And if our forecast of an economic recovery is correct, the U.S. dollar is also what we call an anti-cyclical currency; that when the global economy gets a little bit better, the U.S. dollar tends to depreciate. And with that, as well, the Federal Reserve has undershot its inflation target for a very long time. On average, inflation has been well below 2%, and the U.S. will be more and more targeting having inflation becoming at, or even above, 2%. So, from a relative inflation perspective, the Federal Reserve will keep interest rates very low, and will try to spur inflation and its economy, which typically also is not relatively positive for a currency.
For all of those reasons, we think that we have the making of continued weakness in the U.S. dollar. I think that’s very important to the Canadian investor, because what’s the biggest, second currency that Canadian investor have in their portfolio? It’s the U.S. dollar. We see a number of risk associated with the future weakness of the U.S. dollar.
And finally, if that was not enough, we’ve seen that the U.S., from a structural perspective of its economy, is not well suited to fight the coronavirus. We’ve seen that the healthcare system has not responded well relative to other places, and they will continue to have some challenges. Plus, you have the U.S. election at the end of the year. So, there’s a good case to be made for weakness in the U.S. dollar.
The reverse of that is which currency will appreciate versus the U.S.? Well, you can’t have a depreciation of the U.S. dollar if the euro doesn’t appreciate, so we see some positive bias. We have a positive bias with the euro related to all these negative factors on the U.S. But there’s also a positive element for the euro. They are getting their fiscal sort of house, if you will, in line with the recovery fund that they’re putting together, which should help the euro fight the pandemic better. They already have had the Covid-19 under much better control than the U.S., which will allow the European recovery to be better, which is what we talk in our forecast as well. So, the euro is one currency that could appreciate.
We see a little bit of upside on the Canadian dollar, but not that much. The Canadian economy continues to be challenged, not least with oil prices are not exactly high and Canada is also a high-cost producer. So, we’re going to be lagging a little bit that recovery in the energy sector. Some upside for the Canadian dollar, but not a lot. And again, in the emerging world, there are a number of currencies that are relatively attractive. Not all of them. Again, here, selection is the key word, but there’s a number of EM/emerging market currencies that could be attractive against the U.S. dollar and that’s also providing some opportunities here.