Weak U.S. dollar creates opportunities

Recent Federal Reserve actions are likely to prolong U.S. dollar weakness, prompting a change strategy for currency traders, CIBC’s Michael Sager says.

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U.S. economic leadership and the Fed’s relatively tight policy stance for years contributed to the dollar’s strength, said Sager, vice-president of multi-asset and currency management at CIBC Asset Management.

Even while the greenback was expensive, “it continued to strengthen and become more overvalued,” he said during a mid-September interview.

Since March of this year — when there was a flight to safety that briefly boosted the dollar to near five-year highs — its value has persistently fallen: as of close on Sept. 29, the U.S. dollar index was trading around US$94, well below the 2020 high of US$102.80.

One major contributing factor is the change to the Federal Reserve’s policy framework, Sager said, promising to maintain interest rates near zero until inflation rises moderately above 2% for some time.

“The intention is clear to generate more inflation than we’ve seen in the last five or 10 years,” he said. “That policy framework change will keep the Fed loose. That will tend to undermine the dollar going forward.”

An undercurrent to that is China and, to a lesser degree, Europe claiming some global economic leadership from the U.S., Sager said. “The two key pillars of support for an overvalued dollar have both been eliminated.”

He said there are opportunities in emerging market currencies, particularly the Chinese renminbi, “which has in its favour a relatively high interest rate [and] relatively low volatility.”

Sager, who’s affiliated with the CIBC Multi-Asset Absolute Return Strategy, noted that not only is China becoming a more prominent global leader but the country’s bond market is attracting “a lot of flows” as Chinese bonds are added to major indexes. He expects this to continue through next year.

Other emerging market currencies on his list are the Mexican peso, the Russian ruble and the Indonesian rupiah, all of which are attractive in terms of interest rate carry, current valuation, and long-term fundamentals such as low debt levels and sustainable balance of payments.

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