Self-inflicted wounds weakening the U.S. dollar

There are a number of reasons why the U.S. dollar may be expected to keep progressing lower in the coming quarters. The U.S. dollar is overvalued across the board and the elevated current account balance deficits make it vulnerable to a less strong appetite for U.S. assets by foreign investors. The liquidity of the U.S. dollar is plentiful and there are grounds to believe the U.S. Federal Reserve (the Fed) will resume policy easing. Policy uncertainty remains high, and investor-unfriendly policy choices will likely counter any relatively resilient cyclical data the U.S. economy generates.

The negative policy headwinds are many, and include: trade tariffs; an apparent greater willingness to threaten asset expropriation and punitive tariffs and taxation of foreign assets as leverage to achieve desired policy outcomes; elevated deficits and ballooning government debt; skepticism about the future independence of the Fed; and antagonism towards international students, academic institutions and scientific research. Allied to a more restrictive immigration stance, these policies are unfavorable to long-term U.S. GDP growth and are negative for the long-term valuation of the U.S. dollar. However, a likely push to deliver more deregulation represents a partial mitigation of this situation.

While there has yet been no significant change in the broad usage of the U.S. dollar in international financial transactions, the policy headwinds outlined, and less favourable investor views, do appear behind a change in U.S. asset class correlations. If this change persists, it has important hedging implications for Canadian investors exposed to U.S. assets.

Accordingly, these shifting correlations and our expectation that the U.S. dollar will continue to trend lower have led us to increase hedge ratios on the U.S. equity funds we manage and to position the U.S. dollar as a preferred funder in active currency mandates. Looking ahead, FX hedging activity by non-U.S. investors will create a feedback loop that further pressures the dollar. In this context, we expect the Canadian dollar to strengthen over the next year against the U.S. dollar.

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