How the recovery will affect global currencies

The outlook for a strong economic recovery has helped drive inflation expectations, pushing bond yields to their highest level since before the pandemic. While the U.S. dollar has benefited from the positive environment, its strength likely won’t last, a currency expert says.

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“Lots of the additional positivity around the outlook for global growth has focused on the U.S., with the accelerated rollout of vaccines [and] the Biden administration’s significant fiscal stimulus,” said Michael Sager, vice-president, multi-asset and currency management, at CIBC Asset Management, in a recent interview.

As a result, “The U.S. was leading the charge in terms of growth revisions,” he said. “The U.S. bond market was leading the charge in terms of the move higher in bond yields.”

The 10-year U.S. Treasury yield reached 1.74% at the end of March. And on Tuesday, the International Monetary Fund forecast U.S. growth to be 6.4% this year — its fastest pace since 1984 — and 3.5% in 2022.

However, the factors driving growth suggest the U.S. dollar’s relative strength likely won’t last.

“Fiscal stimulus is positive in the short term, but it means that the fiscal deficit [and] current account deficit of the U.S. economy long term will be that much bigger,” Sager said.

Currencies that haven’t been beneficiaries in the current environment have been those in developed markets where yields are “pinned down right along the yield curve by policy-makers,” Sager said. These include the Japanese yen, Swiss franc and the euro.

For emerging market (EM) currencies, the outlook is mixed. Some have sold off, Sager said. And the IMF noted that the economic rebound will be slower in countries unable to afford fiscal stimulus and those dependent on tourism.

However, currencies in EM markets with fundamentals and policies that have improved over the last couple of decades are attractive in the long term, Sager said.

For the loonie, strong performance may continue. In the first quarter of 2021, the Canadian dollar bested all major currencies, gaining 1.3% compared to the U.S. dollar, boosted in part by rising commodity prices.

The IMF forecasted Canada’s economic growth at 5% this year and 4.7% in 2022, which should continue to support oil prices.

“That will keep a bid to the Canadian dollar against the U.S. dollar,” Sager said. “In the short term, certainly the Canadian dollar could rally against the U.S. dollar by perhaps as much as another 3% to 5% from levels at the end of March.”

National Bank’s Q2 forecast for the loonie against the dollar is C$1.24 and improves from there.

Stronger-than-expected GDP growth, high commodity prices and an “ebullient” housing market set the stage for the Bank of Canada to further reduce bond buying this month, all adding to loonie strength, the bank said in its monthly foreign exchange report.

Given these factors, “We remain comfortable with our target of C$1.20 to the USD in the second half of this year,” the report said.

The loonie is less attractive in the long term among global currencies, however, Sager said.

While Canada compares favourably to the U.S. in terms of productivity, debt and current account balance, it compares less favourably to the most attractive EM countries and currencies, he said, such as the Chinese renminbi, Russian ruble and Indian rupee.

The IMF forecast China’s growth to hit a record 8.4% this year and 5.6% in 2022.

“More broadly, when we survey the currency landscape, we think there are much more attractive long-term opportunities to invest in currencies elsewhere rather than the Canadian or the U.S. dollar,” Sager said.

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