Developed versus emerging market currencies

The bull run for the U.S. dollar may be over. With the greenback overvalued and expensive relative to other currencies, its appreciation will be limited, according to Luc de la Durantaye, chief investment officer at CIBC Asset Management.

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“The U.S. runs a current account deficit, which is often the sign of an expensive currency,” de la Durantaye said in an interview earlier this month.

“The U.S. exports less than they import, and part of that is because of an expensive currency. This is one of the elements that plagues the U.S. dollar. The U.S. economy runs a large fiscal deficit, which can weigh negatively on the currency.”

As a result, the U.S. will have to rein in the fiscal deficit, which will lead to slower growth, he explained. Further, the Fed will likely have to ease monetary policy and the interest rate differential of the U.S. economy versus the rest of the world.

“The U.S. dollar has essentially been supported over the last year or two [by the] normalization of the Federal Reserve’s monetary policy relative to the rest of the world,” he said. The Fed pausing on further interest rate hikes is “relieving” some of the U.S. dollar’s support.

“We see a peaking U.S. dollar,” de la Durantaye said, forecasting that it may be flat against G10 currencies and potentially weak relative to emerging markets.

Canadian dollar

Closer to home, de la Durantaye said Canada remains “plagued” with a current account deficit, which is “weighing on the Canadian dollar, particularly when you look at the non-oil deficit that has still not improved.”

So while the Canadian dollar remains undervalued compared to the U.S. dollar, exports are still down. “Until we see improvement in our net exports, excluding oil, we can’t afford to have a strengthening Canadian dollar,” he said.

As a result, the Canadian dollar remains in a “trading range.” This means that “compared to the U.S., the Canadian dollar can hold its value. But in times of weakness in the global economy, the Canadian dollar cannot afford to appreciate and must continue to remain relatively weak to help turn around our current account deficit,” said de la Durantaye.

Euro

The euro, often called the anti-dollar, according to de la Durantaye, is the second most-traded currency. When the U.S. dollar weakens, he said the euro strengthens because “global currency managers rebalance their portfolios away from the dollar, and some of that finds itself into the euro.”

But, the euro is currently plagued by longer-term structural weaknesses across the eurozone, he said, including political instability in Italy and Brexit uncertainty.

“It’s also plagued by very weak economic activity, weak growth from a cyclical perspective and weak inflation,” said de la Durantaye. “The ECB has not met its inflation target for a number of years, so that forces the ECB to remain more dovish than many central banks.”

Further, negative interest rates aren’t helping the euro. “We have a limited upside to the euro,” he said.

The U.S. dollar is trading around $1.13 for one euro. “If we get to US$1.14 in the next six to 12 months, that would be the highest target that we would see.”

Emerging markets

De la Durantaye said emerging market currencies remain among the most attractive.

“There are certain areas in Asia—Indonesia and India—that are seeing undervalued currencies [and] high interest rates that hold promises for investors to provide attractive returns in the currency market.”

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