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Michael Sager. I’m vice president, multi-asset and currency at CIBC Asset Management.
So the question is where are the opportunities and risks currently in currencies? There’s some big trend changes happening, and one of them and perhaps most importantly focuses on the U.S. dollar. So for a number of years prior to 2020, the [U.S.] dollar was quite strong, even though on most valuation metrics, it looked expensive. So it continued to strengthen and become more overvalued. And partly, that was because the U.S. cyclical economy had growth leadership in the world, and related to that, the Federal Reserve ran a relatively tight policy stance compared to other central banks.
That’s now changed. The Federal Reserve has signalled its intention to maintain a very, very loose policy stance as far as the eye can see and probably beyond. That was solidified at the beginning of September, when the Fed announced a change in its policy framework so that it will now be targeting average inflation; an average inflation rate of 2%. The intention is clear to generate more inflation than we’ve seen in the last five or 10 years. So that policy framework change will keep the Fed loose. We think it will be relatively loose compared to other central banks as well, and so that will tend to undermine the dollar going forward.
Related to that, [and] as the world economy recovers from the Covid shock and the economic shutdowns in the spring of 2020, growth leadership is rotating away from the U.S. and towards particularly China and, to a lesser degree, Europe. So the two key pillars of support for an overvalued dollar — the growth leadership and Fed policy — have both been eliminated. So now we not only have the dollar as being overvalued, but we have catalysts for it to weaken. So we have seen some weakening through the spring and part of the summer. The dollar definitely weakened up, more so versus developed market and emerging market currencies.
But we have now seen the beginning of a trend that we think will be persistent, on average, over the next few years, for the dollar to weaken back towards and perhaps even a little bit below its longer-term fair value. So to us, that makes the U.S. dollar a key source of funding within active currency portfolios.
So then the question of course is, what is it funding? What long positions do we think are attractive? One of the most interesting one is the Chinese renminbi, which has in its favor a relatively high interest rate [and] relatively low volatility. Of course, the Chinese economy, as I mentioned, is assuming growth leadership, which will be currency supportive. But also, the Chinese bond market is attracting a lot of flows, including because the market is being included into benchmark indexes. This has happened through 2020. It will continue to be happening through 2021. So for all of those cyclical and structural reasons, the renminbi has […] particularly looked attractive.
Elsewhere, just to finish up, other emerging markets with strong long-term fundamentals exhibit opportunities. So the likes of the Mexican peso, the Russian ruble, the Indonesian rupiah, for example, all have a relatively attractive interest rate carry, relatively attractive current valuation, but also long-term fundamentals that are attractive relative to other EM or DM currencies — things like low debt levels, sustainable balance of payments. All of these fundamentals are attractive and supportive of currencies. So short the dollar, long the renminbi and long select other emerging market currencies are some of the key opportunities that we see right now.