Boosting Portfolio Performance with Currencies

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Luc de la Durantaye

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Luc de la Durantaye, chief investment officer for CIBC Asset Management.

One important aspect to this global environment is on the currency side. Let’s start with the U.S. dollar. We’ve just published a longer-term paper on the U.S. dollar outlook and one that we see as relatively bearish for the U.S. dollar over a number of years. And the reason being is, they have a number of things where the U.S. dollar is facing headwinds. One is the overvaluation. The U.S. dollar is one of the more overvalued currencies in a universe of 30 currencies or so that we monitor. So, that’s a starting point.

The second point that mitigates against the dollar is this interest rate advantage that the U.S. dollar used to have has been eroded due to the pandemic. In addition, the Federal Reserve has adopted an average inflation targeting approach, which so far it’s still an experiment. But if we follow the experiment that they seem to be pursuing means that they will be very patient with inflation, which means that real interest rates, or nominal interest rates minus higher U.S. inflation, means that U.S. interest rates will offer low to negative real interest rates for a period of time. And so this is also typically a negative element for any currency, that provides negative interest rates.

The third point is a more general point where the U.S. economy has been using, or the U.S. administration has been using the dollar a bit as a weapon, where they’ve sanctioned a number of countries in holding up some of their U.S.-dollar exposure. So it makes foreign economies less and less attracted to the U.S. dollar. So, at the margin — not all economies, of course — but at the margin, there’s a global diversification away from the U.S. dollar.

But those are long important trends that should continue to put downward pressure on the U.S. dollar.

So, who benefits on the reverse side of things? Well, we’ve talked a little bit about the Canadian dollar, at the current cyclical recovery, is conducive to higher commodity prices. The Canadian dollar, on the other hand, starts with a degree of undervaluation versus the U.S. And so that continues to support, from a valuation perspective, the Canadian dollar. Commodity prices will continue to support the Canadian dollar as well. So those are elements that are supportive for our currency gradually over time, and specifically for 2021.

When we look out in the global economy, what other currencies could provide some attractive returns? There’s a number of them that are in the emerging world. Emerging economies like Indonesia, like India, are starting to offer more attractive interest rates. Their interest rates in these economies are still relatively higher in the degree of 4 or 5%. And so that provides a relative income that is higher. There’s a number of emerging currencies that provide that. A number of them are also undervalued versus the Canadian and the U.S. dollar. So, that also provides some tailwind. And typically in an environment where the Federal Reserve stay and keep interest rates relatively low, that provides a tailwind for emerging markets in general, in terms of emerging currencies, in particular.

So those are elements that, also from a Canadian investor, we should be looking at. Be careful relative to the U.S. dollar because of the secular elements, as we mentioned, but also look for attractive boosting your return, by being exposed to the more attractive currencies around the world and that could provide an added return. In a low sort of return environment, currencies can now provide attractive return from that perspective.