Why the decline of the U.S. dollar is a 10-year story

CIBC expert says PMs should be shorting the currency and that its weakening is a positive for global investors

Why the decline of the U.S. dollar is a 10-year story

The weakening of the U.S. dollar is an “unstoppable trend” and one portfolio managers should be factoring into their investment strategies, according to an industry expert.

Michael Sager, VP, Multi-Asset & Currency at CIBC Asset Management, told WP that investors should be positioning to short the U.S. dollar and be aware that any global exposure in any asset class will be affected.

Last month, Sager released new analysis through a report titled The Future of the U.S. Dollar: Dominant currency or one of many? and believes the decline of the greenback is down to multiple reasons both inside of the U.S. and outside.

From inside, the primary driver is the change in Fed policy. The central bank has adopted average inflation targeting and has clearly signalled that its open to generating more inflation, which has occurred at the same time the U.S. Treasury has been printing huge amounts of debt because of the pandemic and subsequent lockdowns.

This is no surprise, Sager said, given that tax increases or service cuts are not viable, popular or likely given the election result. He added: “Or you can generate a bit more inflation and reduce the real value of the debt. That’s the tried and trusted way. It’s a slight shift but an important shift.”

Outside of the U.S. there has been an unintended consequence as a result of foreign policy and the various sanctions imposed. For example, limiting Chinese companies' ability to raise capital in the US is pushing these countries to go elsewhere and use the dollar less. Simultaneously, other countries in the world economy are growing, particularly in Asia. As this continues, the U.S. gradually reduces in influence, which is consistent with less use of the U.S. dollar.

Sager said this shift will be gradual but permanent, although there are areas where it is happening quicker than others.

“An example would be China and Russia trade settlements,” he said. Five years ago, trade between China and Russia, 90% of that was settled in U.S. dollars. The last number we had gathered earlier this year was 45%. That’s an example of where things are really changing. It’s gradually going to happen and I think this is an unstoppable trend.”

Sager declared this an unequivocal positive, however. He stressed that, despite the predicted decline, the U.S. will not go the way of the U.K pound, which just “kicks around in the background” these days. The greenback will still be a hugely important currency, it just won’t be the currency.

He added that the idea of having a dominant currency is all well and good if the world economy aligned but that this is increasingly not the case. Sager highlighted 2018/19 when the U.S economy was relatively strong in terms of growth and started tightening interest rates.

“This was exactly not what Asia needed but they had to follow because they typically keep their currencies tightly aligned to the dollar,” he said. “They inherit that U.S. policy, even though it wasn't appropriate.”

He added: “I always bring it back to Asia. A lot of Asian countries have set policy with one eye on their own domestic fundamentals and one eye on what the Fed is going to do. Whereas, if you don't have such a dominant currency, you can have more diversification in the world.

“Indonesia, or China or India, for example, set policy based on their own economic fundamentals - their currency, their bond market, their equity markets - and they perform based upon what their own fundamentals are doing, not what the U.S fundamentals are doing.

“[More diversification means] you don’t have this transmission of shocks, which is really, really negative.”

A long-term investor, CIBC believes this is a 10-year story in its currency and multi-asset strategy. It is already shorting the U.S. dollar and it represents one of the firm’s big positions.

A lot of the talk right now is of the possible rotation from growth to value but Sager said investors should not stop there and that there are multiple potential rotations out there, including U.S. equity market leadership rotating to international markets.

Sager said: “It’s like a big Venn diagram. You’ve got all these pieces and one of these is the U.S. dollar rotation. They all, to a larger or smaller extent, overlap, but it makes global investing more interesting. It’s always been diversified, but now you know you are investing in emerging markets on emerging market fundamentals rather than on a mix of dollar fundamentals.

“Global investing makes lot more sense. You get a lot less correlation and a lot more diversification. It means you have to do more research. You can't say I'm going to buy EM because there's an awful lot of good in Mexico and China versus Turkey or South Africa, in our mind. The fundamentals in the first ones are really attractive compared to the fundamentals in the last two, for example.”

Sager added that portfolio managers must also recognize that if the dollar is going to become less dominant, then its correlation with equity markets is likely to change. Historically, people have seen it as a safe haven, typically going up when equity markets go down.

He said: “You'd expect that correlation structure changes and that’s important when you're putting together a portfolio allocation. You can’t use yesterday’s strategic assumption.”