Opportunities amid turmoil
Opportunities amid turmoil
[Opportunities amid turmoil]
Vice-President, Multi-Asset & Currency
CIBC Asset Management]
So it's clear that the US dollar has been broadly strong against pretty much every currency this year, including the Canadian dollar. But the source of that strength has been the US Fed and its willingness and commitment to continue to increase policy interest rates until it sees a meaningful decline in the rate of inflation. That's not likely to happen any time soon because some of the slower moving elements of inflation, things like rents and housing costs broadly and wage costs are just too high and showing no evidence of a downturn.
[Aerial shot of a residential housing. Condo buildings and skyscrapers. Aerial shot of a residential housing.]
So until the Fed sees that evidence of weaker inflation, it's going to keep tightening policy. And as long as it keeps tightening policy, the dollar is going to remain strong.
[Signs inflation has peaked?]
The Fed has become increasingly determined in its efforts to regain control of inflation. The measure of inflation that it focuses on strips out volatile components like oil or food, which have shown some evidence of weakening in recent months.
[Combine harvester in a cornfield. Corn cobs being sorted onto a conveyor belt. Farm workers sorting a larger bin of corn cobs.]
Instead, the Fed focuses on a measure of inflation called "core". The main components of core inflation - the main drivers - are housing and rent and wage costs.
And thus far, there's no evidence that any of those more sticky components are showing any signs of weakening. This means that the Fed has quite a bit more tightening to do. But it also is obvious from "Fed speak" that it's very committed to following through with the necessary rate increases. So this is a very different episode from 2018.
Back then the Fed., under current Chairman Powell, started to tighten policy rates, but stopped too soon as it saw a decline in equity markets. That's not going to be the case this time. It's all eyes on control of inflation to a large extent regardless of the damage it causes to financial markets.
With central banks committed to delivering low inflation via tighter monetary policy it means that the outlook for economic growth is increasingly difficult, which in turn means the outlook for corporate earnings is also difficult. That hasn't necessarily been fully reflected in market expectations for equity returns, which suggests that in the near term at least, there is more downside side for broad equity markets. But even within that relatively pessimistic outlook, there are opportunities.
The Canadian equity market looks relatively attractive, both given its valuation compared to other markets, but also its focus on dividends in a number of sectors.
[The Toronto skyline. The Toronto Stock Exchange building.]
Both of those are positive attributes in difficult periods, challenging periods for markets. Fixed income opportunities are getting more attractive. That includes both at the short end of the curve, but also if you think about developed markets, sovereign bonds. Yields have increased quite significantly over the last couple of years as market participants have priced in higher policy rates.
But now yields have moved a lot higher. It means that sovereign bonds can get back to playing their traditional role as a counterweight to equities during challenging periods for equity markets. So bonds become relatively more attractive.
The US Dollar is likely to continue to strengthen against the Canadian dollar for as long as the Fed continues to tighten policy. There are a number of reasons. First, it looks like the Fed will increase interest rates more than the Bank of Canada. Interest rates are a key driver of exchange rates, so more tightening from the Fed suggests that the US Dollar will continue to appreciate against the Canadian dollar. The Canadian dollar is also a very pro-cyclical currency. It does well when the economy does well, when commodity prices do well.
[A rural oil refinery station. Rural oil derrick pumps.]
At the moment, the outlook for economies and commodities like oil has soured. And so that suggests, again, that in the short term, at least, the Canadian dollar is likely to experience a little bit more weakening against the US Dollar. Once we get to the point that the US Fed signals an end to its tightening phase. I think that weakening of the Canadian dollar can start to reverse and will probably regain a lot, if not all, that we've lost over the last few weeks in terms of the level of the Canadian dollar against the U.S.
[The views expressed in this document are the views of CIBC Asset Management Inc. and are subject to change at any time. CIBC Asset Management Inc. does not undertake any obligation or responsibility to update such opinions. This document is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this document should consult with his or her advisor. All opinions and estimates expressed in this document are as of the date of publication unless otherwise indicated, and are subject to change.
Certain information that we have provided to you may constitute “forward-looking” statements. These statements involve known and unknown risks, uncertainties and other factors that may cause the actual results or achievements to be materially different than the results, performance or achievements expressed or implied in the forward-looking statements.
CIBC Asset Management and the CIBC logo are trademarks of Canadian Imperial Bank of Commerce (CIBC), used under license.
The material and/or its contents may not be reproduced without the express written consent of CIBC Asset Management Inc.]
[The CIBC logo is a trademark of CIBC, used under license.]