American businessman holding a pile of 100 dollar bills

The safe-haven U.S. dollar benefited from March’s sell-off, but has since given up its gains. The dollar index is currently trading at its lowest level in more than two years.

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While the dollar could again be boosted by a second wave of global Covid-19 infections, plenty of headwinds weigh on the currency.

“From a cyclical perspective […], we have a certain degree of pessimism around the U.S. dollar,” said Luc de la Durantaye, chief investment strategist and CIO at CIBC Asset Management, in an interview in July.

The dollar’s relative value is one reason for his gloomy view.

“Especially following the pandemic, the U.S. dollar’s rally brought [it] into a fairly expensive level on a broad-based perspective — not only just against the Canadian dollar but against a basket of foreign currency,” de la Durantaye said.

Another factor is the lack of interest-rate premium.

“The U.S. used to have an interest rate advantage over many countries,” de la Durantaye said. With the Federal Reserve holding its benchmark overnight lending rate near zero since mid-March, “the relative interest rate is no longer supporting the U.S. dollar.”

He also noted that the dollar is a counter-cyclical currency that tends to rally during times of stress. As the global economy recovers, the dollar would tend to depreciate.

Further, a potential rise in inflation would be a negative factor.

“From a relative inflation perspective, the Federal Reserve will keep interest rates very low, and will try to spur inflation and its economy, which typically also is not relatively positive for a currency,” de la Durantaye said.

Other factors weighing on the dollar include this year’s U.S. election and the country’s challenges fighting the coronavirus.

“For all of those reasons, we think that we have the making of continued weakness in the U.S. dollar,” de la Durantaye said.

A weaker U.S. dollar presents risk for Canadian investors, who typically have significant exposure to the U.S. market, he said. A relatively stronger loonie would negatively impact foreign investment returns if currency were unhedged.

At the same time, de la Durantaye forecasted little upside ahead for the loonie, given Canada’s struggling economy and energy sector.

Recent loonie strength boosted by better crude oil prices is set to reverse, said a foreign exchange report last week from CIBC Capital Markets, “as relatively weak [trade] fundamentals are revealed, and the global economic recovery stalls.”

While the USD/CAD exchange rate has been about $1.34, CIBC Economics forecasted it to reach $1.37 in Q3 and $1.38 in Q4. For 2021, its outlook ranged from $1.37 in Q1 to $1.41 in Q4.

A currency that’s appreciated against the dollar in recent weeks is the euro.

Considering the negative factors for the dollar, “we have a positive bias with the euro,” de la Durantaye said. Further, relative to the U.S., EU countries have Covid-19 under better control, allowing for a better recovery, he said. Fiscal response has also been supportive.

The CIBC report said it expected the euro to give back some of its recent gains in the upcoming quarter given expectations for a risk-off environment. Still, the EUR/USD exchange rate would retain a longer-term target of US$1.19, it said.

Certain emerging market currencies may also be attractive against the dollar so long as investors discriminate. “Selection is the key word,” de la Durantaye said.

The CIBC report noted tactical opportunities in the near term for the currencies of Mexico, Colombia and Chile. Those will dissipate toward year-end, it said, amid various intrinsic challenges in those countries.

For a full currency outlook through 2022, see the CIBC Capital Markets foreign exchange report.

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