High rates a ‘boon’ for active currency investors

By Maddie Johnson | October 16, 2023 | Last updated on October 16, 2023
2 min read
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Higher interest rates and wider differentials between currencies are a “boon” for active currency investors, according to Michael Sager, deputy chief investment officer, multi-asset currency management at CIBC Asset Management.

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“Interest rates are one of the key drivers of currency direction and currency returns,” Sager said in a recent interview. “If you have wider differentials, you have more opportunity to add value.”

According to Sager, the current interest rate differentials are close to two-decade highs, making the currency market particularly attractive for investors seeking to maximize returns.

However, Sager also pointed out that the rapid rise in interest rates over the past 18 months was not entirely expected by market participants. This unexpected shift has repercussions for market sentiment and emerging market currencies.

The resilience of the U.S. economy has played a significant role in driving interest rates and yields higher. According to Sager, it is the U.S. economy that is primarily driving central banks’ inclination toward a “higher-for-longer” policy stance, contributing to the strength of the U.S. dollar.

“Given that it’s the U.S. economy that’s in the driver seat, this is very positive for the U.S. dollar,” he said.

Despite expectations for a stronger U.S. dollar for the next three to six months, Sager said it shouldn’t have a significant impact on other economies.

“Oftentimes, a strong dollar will impact import and export demand in other countries,” Sager said, affecting inflation rates. “That’s certainly in play at the margin, but much more important at the moment is just the general tightness of central bank policy around much of the global economy.”

Europe is in a recession, Sager said, creating a “quandary” for the European Central Bank as it tries to bring inflation back to target levels. China, on the other hand, is stimulating growth through policy easing, which is at odds with the policies of many developed market economies.

Sager expressed a cautious outlook for the Canadian dollar. He said weaker GDP growth, an overvalued housing market and negative productivity mean the Canadian dollar will likely be weaker against the U.S. dollar for the next three to six months.

Productivity, in particular, plays a pivotal role in currency attractiveness by influencing capital flows. The negative productivity trend in Canada does not bode well for the inflow of capital into the country, which, in turn, affects the Canadian dollar.

Sager also noted that while oil prices have shown some strength recently, this would not be enough to bolster the Canadian dollar, leading to a “relatively negative view on the Canadian dollar in the short term.”

That said, Sager said the U.S. dollar is expensive and he expects the Canadian dollar to recover over the longer term.

In this environment, Sager said investors should consider including an active currency allocation to diversify portfolios.

This article is part of the AdvisorToGo program, powered by CIBC. It was written without input from the sponsor.

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Maddie Johnson

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