Rising Rates to Create Currency Winners and Losers

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Michael Sager

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Michael Sager, executive director, multi-asset and currency management at CIBC Asset Management.

Looking out through 2022, which currencies will be most negatively impacted by rising interest rates, and which currencies do we favour in this environment? I think the best place to focus is in the developed markets. And the currency that we think will likely be most negatively impacted by rising rates is the Euro. It’s really straightforward why we think that if you compare what the Federal Reserve in the U.S. or the Bank of Canada is trying to do with what the European Central Bank is expected to do.

For the Fed and the Bank of Canada, they’re clearly laying out a path to higher interest rates. And so they’re withdrawing a lot of the policy stimulus that they introduced into economies in the immediate aftermath of the March 2020 Covid shock. In Europe, the situation is very different. 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.

That really reflects differences in economic conditions. The underlying growth of the European economy in particular remains a lot weaker. The risk of inflation pressures becoming entrenched in the European economy are relatively low. Whereas in the U.S. and Canada, central banks are proactively raising interest rates, or have indicated that they will be raising interest rates, to ensure that that inflation pressure does not get embedded into the broader economy. That difference in interest rates is really important. And with the European Central Bank very unlikely to raise rates for a long time, it suggests that 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.

In terms of the currencies we like, we try to focus on long-term fundamentals. Which currencies have got the most attractive long-term fundamentals by this I mean, productivity growth, strong balance of payments, low debt rates, and fundamentals very similar to that? If you do that analysis, you tend to find that most of the attractive currencies remain in the emerging markets. Names such as the Indian rupee or the Indonesian rupiah. Those would be the currencies from a long-term perspective that we like.

In the very short-term, the next few months with the Fed raising rate and the markets trying to digest how much rates will go up in the U.S., there’s quite a good possibility that the U.S. dollar will find some 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. Early in 2022, the dollar might find a bid particularly again against the Euro. The Yen, for instance. But as we get into the second half of 2022, the U.S. dollar looks much less attractive. And again, we concentrate on long-term, fundamentally attractive currencies, and many of those are in the emerging markets.