Rising rates to create currency winners and losers

As interest rates rise around the world, investors should look for opportunities — and areas to avoid — in their currency exposure, a currency expert says. 

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Michael Sager, vice-president, multi-asset and currency with CIBC Asset Management, said inflation and the monetary policy response will likely hit the euro hardest.

The Federal Reserve and the Bank of Canada are laying out a path to higher interest rates, Sager said in a Jan. 28 interview, withdrawing stimulus that began early in the pandemic.

“In Europe, the situation is very different,” he said. “The European Central Bank, we think, will not be raising interest rates certainly through the whole of 2022, and probably through much of 2023 as well.”

Part of the reason is that the European economy’s underlying growth is significantly weaker, and therefore the risk of inflation becoming rooted is relatively low, Sager said. With rate hikes less likely, the euro is vulnerable.

“That’s our main pick for currencies to be most negatively impacted through 2022 by the outlook for interest rates across a wide set of countries,” he said.

Last week, pressure increased for European policy-makers to act as the latest reading showed inflation in the 19-country zone rose by an annual 5.1% in January.

At the European Central Bank’s Feb. 3 policy meeting, President Christine Lagarde declined to repeat her previous comment that a rake hike this year was “very unlikely.”

Sager said he determines which currencies are most attractive by focusing on long-term fundamentals: productivity growth, strong balance of payments and low debt rates, among other factors. 

“We concentrate on long-term, fundamentally attractive currencies, and many of those are in the emerging markets,” he said, pointing to the Indian rupee and the Indonesian rupiah. 

In the short term, with the Federal Reserve set to raise rates and markets trying to figure out by how much, Sager said there’s a possibility that the U.S. dollar will find support in the early months of 2022.

“But once that digestion of information is complete, you’ll be left with a U.S. dollar that looks expensive and does not have attractive fundamentals,” Sager said.

Therefore, as we get into the second half of 2022, he said the U.S. dollar looks much less attractive.

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Maddie Johnson

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