High inflation and rapidly rising interest rates have put pressure on most publicly-traded asset classes this year. Inflation and interest rates have been front and centre over the past few weeks, as the hawkish messaging from the U.S. Federal Reserve was that more interest rate hikes are on the horizon. This messaging led to an increase in equity and bond market volatility, and a fall in prices. Volatility in global currencies has also increased significantly, with the U.S. Dollar gaining strength and the UK Pound falling precipitously. We explain more below.

 

The U.S. Dollar has been riding high this year, driven by several factors. First, a general flight to safety, with investors seeking the liquidity and safety offered by the USD. Second, aggressive rate increases by the U.S. Federal Reserve, compared to other global central banks, 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 growth headwinds and energy security issues that have arisen, the U.S. is seen as more economically insular and resilient, with the ability to navigate through the challenges that lie ahead.

 

The U.S. Dollar has reached levels, relative to most other major currencies, that have not 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 almost 20% relative to the British Pound. The Pound has been the most noteworthy, as it has come under significant stress in recent weeks and now sits at an historic low relative to the U.S. dollar. The UK government, newly formed just three weeks ago, issued a surprise announcement that it would cut taxes to assist citizens with inflation and, in the process, stimulate its economy. This decision was at odds with the tightening policy of the Bank of England, which has been raising its policy forcefully in an effort to lower demand and cool inflation. The inconsistency further eroded investor confidence.

 

Canadians naturally pay the 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 occurred over the past month, as the Loonie was quite resilient earlier in the year. The Bank of Canada has been as aggressive, if not more so, than the U.S. Federal Reserve with its interest rate policy. In addition, the strength in Canadian commodity prices 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 than is the U.S., given higher levels of household indebtedness.

 

It is hard to assess exactly where currencies will go from here. Currency prices have been notoriously difficult to predict with any consistency through history. They can move to extremes from time to time, only to be followed by a reversion to the mean. It is possible that we are now experiencing such a scenario. In the meantime, the U.S. Dollar exposure that we have in our portfolios has provided its customary hedge against global stock market declines, in what is proving to be a difficult year.

 

If you have any questions, please do not hesitate to contact us.

 

Drew M. Pallett LL.B. CFP

Senior Portfolio Manager and Investment Advisor 

RBC Dominion Securities

Email: drew.pallett@rbc.com

Website: www.pallett.ca