Current environment favours U.S. dollar strength

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Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

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Michael Sager, managing director and CIO of multi-asset and currency management at CIBC Asset Management. 

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In January, we discussed that the U.S. dollar would likely remain strong during the rest of 2025, and that the Canadian dollar would face some challenges. So let’s update that to the end of February. 

The U.S. dollar has weakened off, actually, a little bit since the last month. But if we look at the broad macro environment, it’s one that is still, we think, conducive to the U.S. dollar remaining broadly strong. 

The U.S. economy is still the strongest major economy in terms of growth. The Federal Reserve has become more hawkish in terms of its interest rate policy outlook, compared to other central banks including the Bank of Canada. And, of course, the general environment remains very uncertain. 

Whenever we get a period of high uncertainty, high market stress, that’s typically conducive for U.S. dollar strength. 

So, if you put together the pieces — continued outperformance of the U.S. economy, a relatively hawkish Federal Reserve, and a very uncertain macro and political environment — the scene is set for the dollar to remain relatively strong and certainly to continue to trade far above a level that we would think is its long-term fair value. So, a stronger-for-longer U.S. dollar. 

For the Canadian dollar, a lot of the news over the past month has been about tariffs. At the beginning of February, the Trump administration announced much more Draconian tariffs than we and the market had expected. These were subsequently suspended for a month, but it looks like the best assumption going forward is that there will be some additional tariffs on the Canadian economy. 

At the margin, that will be negative for the Canadian dollar. That will likely lead the Bank of Canada to ease its monetary policy a little more than it would have done.  

And so, again, at the margin, a greater tariff risk, more cutting by the Bank of Canada and higher uncertainty suggests that the Canadian dollar will likely remain weak throughout the remainder of 2025, and certainly will continue to trade below a level which we would associate with its fair value — and quite meaningfully below that level, perhaps 15% cheap to that fair value. 

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So, what is the outlook for other global currencies, like the euro and the yen? 

For the euro, there are a number of risks that tend to be skewed to the downside. The European economy has remained weak. The European Central Bank is cutting interest rates. Domestic European politics remain confused and difficult. Chinese competition — particularly in electric vehicles — remains fierce. And China as an export market for, for instance, European capital goods remains very weak. So, if you put all of those factors together, the outlook is quite difficult for the euro. 

And then, there are two other factors. 

First, again, tariffs. We had expected some targeted tariffs focused on the European auto sector. The risk is that tariffs are more extensive. This will be negative for the euro. We don’t think the markets are pricing in enough of a discount for the euro. As of Feb. 21, the euro was trading at about US$104.50 against the U.S. dollar. We think that it would depreciate, it will weaken from that level given tariff risk, given all of the other risks I mentioned. 

And then the other big uncertainty is Ukraine and the possibility of a ceasefire. Let’s see how that develops. It could either be positive or negative depending on the terms. 

So our bias is for a lower euro. 

On the yen, the yen tends to be used as a hedge. So we like the yen in periods of elevated uncertainty like today. In addition, though, the Japanese economy finally, after three-and-a-half decades, seems to be achieving a self-sustaining recovery, an exit from disinflation or deflation. 

Inflation numbers for January were quite constructive. So we’re beginning to become increasingly positive on the yen. Japan doesn’t seem to be as exposed as the euro area, China or even Canada to the risk of U.S. tariffs. So we’re constructive on the yen. It looks very cheap and could appreciate a long way. 

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How about the outlook for emerging market currencies? 

Here, it’s a really mixed bag. You really have to focus on individual country and currency fundamentals. For those with attractive fundamentals, cheap valuations, high interest rates, strong domestic growth — like Brazil, Colombia, South Africa — we are very constructive. We like those currencies. The risk is that we’re in such an uncertain environment that that’s a headwind. EM assets broadly — whether it’s FX, bonds, equities — do not do well or as well as fundamentals would argue in periods of heightened uncertainty. 

So, be very aware of idiosyncratic fundamentals like currencies with strong fundamentals. But size positions accordingly, given the uncertain macro and political environment. 

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What is my outlook and advice for investors in a period like this of heightened uncertainty? 

Well, let’s step back from currency and just think about portfolios more broadly. There are always reasons to have nervousness and fear. In the long term, what matters are fundamentals, whether that’s fundamental drivers of equities, corporate returns, interest rates for bonds, and so on, and so forth. 

And so it’s important to focus on those fundamentals in the context of an individual’s long-term performance objectives. That’s the best way to achieve performance consistent with those goals and objectives. 

Trying to time market participation typically doesn’t work. So stick with the long-term, stick with fundamentals and a well-diversified portfolio. That would be my strong recommendation.

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