Inflation, rising rates shaping currency outlook

With the global economy recovering from the Covid-19 pandemic, investors may want to consider their currency exposures, CIBC Asset Management’s chief investment officer says.

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Movement of the U.S. dollar, or the “big dollar” as Luc de la Durantaye calls it, is complicated to forecast “because the drivers are going in opposite directions.” 

From a monetary policy standpoint, the Federal Reserve is ahead of some other central banks in its tightening path, de la Durantaye said, which has provided support to the U.S. dollar early in the year. Many analysts expect the Fed to raise interest rates three or four times this year.

However, de la Durantaye said the fundamentals suggest the U.S. dollar is overvalued. Inflation is higher in the U.S. than in many other places, which he said will likely pull the dollar back down as “long-term high inflation usually depreciates a currency.”

For this reason, he predicts the U.S. dollar to trade higher at the beginning of the year, but as policy evolves, the dollar could peak and subsequently retrench. 

By contrast, de la Durantaye said the Canadian dollar is “interesting” because not only will the Bank of Canada also raise interest rates, but the Canadian dollar is supported by rising commodity prices.

Early in the year the Canadian dollar could jump to around US$0.82, he said (the loonie was trading below US$0.79 on Wednesday after the Bank of Canada held its overnight interest rate). But the loonie is likely to retreat to around US$0.76 later in the year as the global economy slows — especially if commodity prices “roll over” and the Bank of Canada slows its tightening. 

Globally, a number of currencies depreciated in 2021, which de la Durantaye said can provide an attractive entry point for investors. For example, the Russian ruble, the Brazilian real and the Mexican peso all provide very high interest rates.

“Their central banks have been tightening well ahead of the Federal Reserve and so they provide high carry and undervaluation, which are potentially attractive as investments for 2022,” said de la Durantaye.

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Maddie Johnson

Maddie is a freelance writer and editor who has been reporting for Advisor.ca since 2019.