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In the uncertain pandemic environment, Canadian investors looking to boost returns may want to reconsider their currency exposures. In particular, shorter-term investors may want to hedge U.S.-dollar exposure as certain secular trends are expected to put downward pressure on the U.S. dollar, says Luc de la Durantaye, chief investment strategist and chief investment officer with CIBC Asset Management.

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The dollar’s longer-term outlook is “relatively bearish,” as it faces several headwinds, de la Durantaye said in an interview on Jan. 11.

The first challenge is overvaluation. “The U.S. dollar is one of the more overvalued currencies in a universe of 30 currencies or so that we monitor,” de la Durantaye said.

Second, the dollar has long lost its interest rate advantage since the Federal Reserve slashed its benchmark rate near zero last March in response to the pandemic.

Adding to the effect, the Fed adopted a framework for inflation to average 2% over time. While the new inflation measure is “still an experiment,” de la Durantaye said, it means the Fed will be “very patient” when considering rate hikes.

As a result, U.S. real interest rates will be low or negative for a period. “This is typically a negative element for any currency,” de la Durantaye said.

A third headwind for the dollar is the potential for its global use to decline.

“The U.S. administration has been using the dollar a bit as a weapon,” de la Durantaye said, referring to U.S. sanctions on countries such as Russia and Iran, blocking their access to dollar-dominated markets.

Such sanctions “make foreign economies less and less attracted to the U.S. dollar,” he said. “At the margin, there’s a global diversification away from the U.S. dollar.”

The loonie, on the other hand, is likely to appreciate, de la Durantaye said. The Canadian currency is undervalued relative to the U.S. dollar and will benefit from rising commodity prices as the economy recovers from the pandemic.

“Those are elements that are supportive for our currency gradually over time, and specifically for 2021,” de la Durantaye said.

In its latest outlook, Desjardins said the Canadian dollar is “likely to surpass the US$0.80 mark in the coming quarters.” National Bank’s forecast, made about three weeks ago, was US$0.83 by year-end.

Several emerging markets (EMs) are also poised for currency appreciation, potentially providing attractive returns for investors.

“Emerging economies like Indonesia [and] India are starting to offer more attractive interest rates” of about 4% to 5%, de la Durantaye said. “That provides a relative income that is higher” compared to Canada and the U.S.

And many EM currencies are undervalued relative to the loonie and dollar, providing another tailwind, he added.

EMs will also benefit from an environment where the Federal Reserve keeps interest rates low, de la Durantaye said.

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