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Long-term investors should look to hedge U.S. dollar exposure: Larry Berman - BLOOMBERG

DECEMBER 04, 2024

The Canadian dollar began floating versus the U.S. dollar after the fall of Bretton Woods in 1971. Since that time, the loonie versus greenback exchange rate has average 1.23, but has spent almost no time at all at that level. The two primary drivers of exchange rates are relative levels of growth and inflation best measured by the difference in two-year note rates (green line) to represent capital account flows (the next sum of money buying foreign assets and foreigners buying Canadian assets).

The current account is the net sum of trade dollars leaving and coming into Canada. This is historically best represented by our biggest export: energy (purple line is the West Texas Intermediate price inverted).

As the chart shows, it has spent very little time above 1.42 (or below 70 cents). The longest period was in the late 1990s and early 2000s when twin deficits were the biggest net currency outflow. To fix this, the Bank of Canada increased rates significantly about the U.S. Federal Reserve (green line lower).

Historically, the green line and Canadian rates have always been at a higher rate than in the U.S. Since the Global Financial Crisis, rates have convergence and in general, both Canada and the U.S. have had very low rates; near zero.

But Canada has failed to benefit in recent years from the rise in oil prices and foreign investment in Canada has been anaemic to be sure. This is a huge failure of the current government related to some of our most valuable exports. The structural weakness in Canada and the much higher interest rate sensitivity has hurt the Canadian dollar in recent years. That may continue with Donald Trump’s tariff plans for the next few years.

In the short run, the Canadian dollar is likely to get weaker. In the long run, investors should start thinking about hedging foreign exposure. In the exchange traded fund (ETF) world, shifting to a currency-hedged strategy makes sense. The other complicating factor in the short run is political uncertainty in Europe that seems to be pushing the euro towards parity to the U.S. dollar. That could see the Canadian dollar hit 1.42/1.43 and maybe even 1.45. These would all be longer-term targets for investors with lots of foreign assets to hedge.

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