Currency can have a big impact on returns, so now might be a good time to consider portfolio exposure—especially amid a persistent narrative of slow economic growth.
Investors are likely familiar with the loonie’s recent depreciation against the U.S. dollar, but they should look for a lift to the loonie later this year.
Why? First, consider what’s been weighing on the loonie. In a monthly foreign exchange report, National Bank said worsening interest rate spreads between Canada and the U.S. are a key factor in the loonie’s depreciation. In fact, a dovish Bank of Canada and soft economic data have markets pricing in a rate cut by year-end. The central bank cut its 2019 GDP growth forecast for Canada to 1.2% from 1.7% in its April monetary policy report.
Further, speculators have continued to short the loonie, adding to its challenges. “It’s now 58 consecutive weeks that they’re betting against the Canadian currency, the second longest stretch on records,” the report said.
Yet, the central bank might be underestimating GDP growth, considering oil production is returning to normal and Canada is expected to benefit from stronger U.S. imports in the second quarter, the report said. National Bank’s 2019 GDP forecast remains unchanged at 1.6%.
If that more upbeat view of Canada’s economy is correct, market participants will likely reconsider that priced-in rate cut. Also, any subsequent appreciation in the loonie would be amplified by a reversal of speculative net short positions.
National Bank forecasts USDCAD at 1.30 at year-end, though the report added that the forecast assumes no further trade troubles and positive developments on the United States-Mexico-Canada trade agreement.
For the U.S. dollar, the Federal Reserve’s stance to refrain from raising rates this year has helped stocks more than hurt the dollar, the report noted, with positive U.S. economic data likely benefiting the dollar.
However, the U.S. dollar could be challenged over the near to medium term.
National Bank expects global economic growth outside the U.S. to bounce back later this year, and, with the Fed not hiking in 2019, the U.S. yield advantage is unlikely to rise further. Again, any rebound in global growth depends on tempered trade woes.
Reducing U.S.-dollar exposure
Rebounding global growth is part of the reason why one firm is reconsidering its portfolio positioning in the context of currency.
In a weekly report, Richardson GMP said that, while the firm has been pro-U.S.-dollar-exposure the last few years, some minor currency hedging or reductions in U.S.-dollar exposure are now part of its game plan based on, for example, a stabilization or partial re-acceleration of growth in the second half of the year. That outlook is based on improving economic data for China and rising leading indicators, the report said.
While the U.S. dollar may be a safe-haven currency, global growth motivates investors to add risk, with emerging markets, Europe, Canada, Australia and Asia tending to benefit from higher trade activity, the report said.
As such, Richardson GMP expects the U.S. dollar to move lower in the near-term, though it noted that a trade-war flareup would dampen or delay that move.
It also noted that U.S.-dollar exposure can be a strong risk diversifier for Canadians, who tend to have ample Canadian-dollar and TSX exposure. For example, U.S.-dollar exposure smooths out market performance as global growth slows or when investors are preparing for a potential bear market.
For now, “We still like USD exposure in our portfolios,” the report said, “but more as a diversification tool as opposed to a returns enhancer.”
For full details, read the reports from National Bank and Richardson GMP.