Good afternoon,
First and foremost, today is very close and personal to me and my family as it honors the children who never returned home and Survivors of residential schools, as well as their families and communities. I would like to personally thank all of you for wearing orange to honor the Survivors and for your continued support.
On the markets…
High inflation and rapidly rising interest rates have put pressure on most assets this year. Those issues were front and center over the past few weeks as the messaging from central banks like the U.S. Federal Reserve was that more, rather than less, rate hikes may be on the horizon. Unsurprisingly, that led to a pickup in equity and bond market volatility, and a subsequent fall in prices. Another, albeit less talked about asset class, has also seen extensive volatility of late: currencies. We explain more below.
The U.S. dollar has been riding high this year, driven by a few factors. More specifically, a general flight to safety with risk aversion driving many investors to seek the liquidity and safety typically offered by the U.S. dollar. Moreover, an aggressive central bank compared to others has provided a relative yield advantage in the U.S., thereby attracting some capital. Lastly, while the U.S. economy is by no means immune to the inflation dynamics, growth headwinds, and energy security issues that have arisen, it is seen as more resilient, with the ability to navigate through the challenges that lie ahead.
To put things in perspective, the U.S. dollar has reached levels, relative to most other major currencies, that haven’t been seen in decades. Year-to-date, it has appreciated more than 20% relative to the Japanese Yen, nearly 15% relative to the Euro, and close to 20% relative to the British pound. The latter has perhaps been the most noteworthy as it has come under significant stress in recent weeks and now sits at a historic low relative to the U.S. dollar. The government, newly formed just three weeks ago, surprised nearly everyone with an announcement it would cut taxes to help its economy. That decision flies in the face of the Bank of England, who has been raising rates forcefully in an effort to lower demand and cool inflation. In other words, the policies are at odds with each other and have clearly eroded investor confidence, which was not high to begin with.
As Canadians, we naturally pay most attention to the Canadian dollar. It too is lower this year, by a less noteworthy amount, having fallen by close to 7% relative to the U.S. dollar. Nearly half of that decline has come over the past month as the loonie had been quite resilient earlier this year. The Bank of Canada has been as aggressive, if not more, than the U.S. Federal Reserve with its interest rate policy. Moreover, the strength in commodities witnessed through the first half of the year offered meaningful support for the loonie. Nevertheless, growth concerns have started to permeate across global markets and commodity prices have weakened of late, leaving the Canadian dollar more vulnerable over the past month. Another source of concern is the Canadian economy itself which may be more sensitive to higher interest rates compared to the U.S. given higher levels of household indebtedness.
It is hard to know exactly where currencies go from here. After all, they have been notoriously difficult to predict with any consistency through history. Yet, we recognize they can move to extremes from time to time, only to then be followed by a reversion to the mean. It’s possible we are experiencing such a scenario. Regardless, we’ll continue to appreciate the U.S. dollar exposure we have in our portfolios as it has proven to offer a bit of a hedge in what is proving to be a difficult year.
Please continue to call us as our team stands ready to listen and speak with you. We can also be made available to speak with any friends and family members who may need reassurance during these times.
Have a great weekend,
Devin