BMO GAM’s Head of ETF Strategy explains why the USD is rallying and how advisors can make currency adjustments more frequently
Last year’s big geopolitical shock, the onset of US global tariffs, resulted in a broad shift in the US dollar. The greenback declined and USD-denominated assets struggled as foreign exchange markets shifted to a short-USD position as consensus. Trade barriers erected by the United States were seen as a US-specific shock and currency markets moved accordingly. This year’s big geopolitical shock, however, has served to have the opposite impact on the greenback.
US dollars have been one of the few assets to strengthen in the wake of the US-Israeli war with Iran. Bipan Rai, Managing Director, Head of ETF and Alternatives Strategy at BMO Global Asset Management, explained that while the US is a player in this conflict, the economic shock is being felt globally. As a result, currency consensus has shifted and money managers are moving away from their short USD positions.
“This is a very, very different backdrop relative to where we were post Liberation Day, when a lot of the focus was really on a US-specific shock, namely that trade barriers were going up in the United States and there was a palpable concern that that could lead to a significant degree of import prices rising in the United States and really choking off growth there,” Rai says. “This is a little bit different in the sense that it’s not necessarily US-specific. I mean, in the conflict the US is involved, but this is more or less just sort of a macroeconomic shock, a little bit more broader than something that’s US-specific.”
Rai explained what this shift in the US dollar means for retail investors and advisors, who rarely play FX markets directly and carry currency risk through securities. He outlined how dynamics in the gold market also play into the broader shift in assets and spoke to some of where investors can find safe havens now. He says that this moment lends itself to a more tactical approach to currency by advisors, who can leverage the constantly growing shelf of products available in Canada to make currency hedging decisions more effectively.
While normally a geopolitical shock like this would also see some investors moving into gold alongside USD, the recent run-up in gold prices has meant that more investors are taking profits from the yellow metal. Rai also notes that given the conflict’s potential shock to both growth and inflation, there is an impulse for gold investors to sell. He makes the point, too, that the pullback in gold can be driven by sales of bullion by the gulf states currently acutely impacted by war with Iran. Those countries are losing out on billions in oil revenues, and are selling gold to plug those revenue gaps.
While gold may be pulling back, Rai does see one other safe haven for investors beside the greenback: commodities. He notes that diversified commodity portfolios have performed quite well this year, especially given some of the positive correlation we’ve seen between stocks and bonds taking place since the conflict broke out.
For retail investors and their advisors, though, currency dynamics are being most acutely felt in hedged exposures to US assets. Hedging is downgrading performance, exacerbating downturns in US dollar denominated assets and muting upside. Rai notes that given the strong consensus towards a short USD position taken before this conflict, some Canadian investors may be over-indexed towards USD hedges. He also sees risks associated with the increasingly strong consensus that the Bank of Canada will, eventually, start hiking interest rates again. He notes that while the inflationary shock of this war may put some pressure on the BoC to hike, a prolonged conflict and high energy prices could see growth stall, which would then result in a revision of those hiking bets and put pressure on the Canadian dollar.
In the past, CAD’s exposure to energy prices might have been supportive for the currency against the USD, and therefore supportive of hedging strategies. Rai notes, however, that until we see greater capital expenditures in the oil and gas sector, the Canadian dollar won’t exhibit that tie to energy prices. Because that kind of cap-ex is so long-term, as well, he doesn’t see this momentary price spike in energy as enough to motivate a new wave of cap-ex.
The core takeaway for retail advisors is, in Rai’s view, that unhedged positions will likely outperform in the short to medium-term. This moment, he says, should make more advisors and investors think of foreign exchange as a risk mitigation tool that can be approached tactically. He advocates for quarterly reassessments of hedged and unhedged positions, based on an outlook of where the USD is heading relative to CAD. He notes that these decisions don’t have to be zero-sum, and that 50/50 positions can work in moments without clear direction. Regular updates, however, can make currency into a source of protection rather than risk. Rai also notes that as the product shelf in Canada has grown, with more hedged and unhedged versions of specific strategies. That allows for a greater ease of movement between currency positions, allowing the retail advisor more discretion and flexibility.
“Currency decisions should be more tactical in nature as opposed to being more strategic. I think that’s just prudent and it makes sense for investor portfolio decisions because there will be quarters where currency movements will be quite forceful enough and quite strong enough to offset returns of the underlying,” Rai says. “At the end of the day, the foreign exchange exposure and the decision to hedge should really be all about risk mitigation as opposed to seeking an additional source of return. So I would encourage advisors to look at it from that perspective.”
