U.S. Dollar to Remain Dominant While Inflation Rises

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Luc de la Durantaye

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Luc De la Durantaye, chief investment officer, CIBC Asset Management.

Well, the U.S. dollar, first of all, has been extremely strong by historical standard. And that has led the dollar to be fairly overvalued, one of the most overvalued currencies in our universe. But for the dollar to turn and weaken from here, you require a trigger. And that trigger we don’t see just yet. The dollar has been strong essentially because the Federal Reserve and the U.S. economy has remained the strongest economy around the world and the least affected, if you will, by some of the geopolitical elements.

Think of it this way, is Europe is faced with an energy crisis. Europe is much more dependent on energy than the U.S. The U.S. is actually exporting energy today, which is different than in the past. And that the resiliency of the U.S. economy is much stronger than Europe. And so, what drives currencies typically is the relative monetary policy, the relative interest rate differential. And in that sense, the Federal Reserve is amongst the most aggressive central banks relative to Europe, relative to Japan, relative to China. And so, it has interest rate support and will continue to have interest rate support for a while longer.

And some of the inflation numbers are also fairly sticky in the U.S. relative to other places like China, for example, where inflation is around their target. And so, that’s really what has been driving the dollar.

And to a certain degree, to a lesser degree, but still an element is the safe haven aspect of the U.S. dollar. When you look at the geopolitical environment with Russia continuing the conflict in Ukraine, Europe is much closer to that epicentre. And the uncertainty around China and the transfer of power with the central government there mean the U.S. dollar remains a fairly attractive currency, safe haven currency at that point.

I might add that in relative terms, the U.S. dollar has been strong, but relative to the rest of the world, the Canadian dollar has also been more on the strong side, helped by its neighbour, the U.S. And the Canadian dollar has depreciated against the U.S. but has appreciated versus a number of other currencies, like the Australian dollar, the New Zealand dollar for example, and the Euro and the U.K.

And so, the Canadian dollar in relative terms, yes, has been underperforming the U.S., but has been stronger against other G7 currencies for similar reasons. And so we don’t see an immediate change in this environment. The only change that we could see is that, as we further advance in the tightening of the Federal Reserve, we will eventually see a peak in inflation. And eventually get a signal from the Fed that they will pause, not reverse, but they will pause.

That may trigger some profit taking in U.S. dollars, but we’re not quite there yet in that scenario.