Canadian investors have remained heavy buyers of U.S. stocks, despite chills in the Canada-U.S. relationship.vtwinpixel/iStockPhoto / Getty Images
The strengthening dollar could help raise the profile of currency-hedged investments for Canadians investing in U.S. assets, as some experts see language from the Bank of Canada and the U.S. Federal Reserve hinting at a possible divergence in monetary policy.
The loonie rose more than half a per cent against the U.S. dollar on Thursday, bringing its gains for the month to more than 2 per cent. The rise came a day after the U.S. and Canadian central banks left interest rates unchanged, in line with expectations, but hinted at different outlooks.
In a note to clients, Stephen Brown, chief North America economist at Capital Economics, said the Federal Open Market Committee’s statement and dot plot were “arguably not as hawkish as many speculated.” He expects the FOMC “will look past a relatively short-lived inflation spike, particularly once Kevin Warsh takes the helm.”
In contrast, Bank of Nova Scotia economist Derek Holt concluded in a note that Canada’s central bank had delivered “a hawkish hold” on interest rates, as Bank of Canada Governor Tiff Macklem warned of the risk of high energy prices translating into broader inflation.
The subtle split may help to support the loonie as the gap between U.S. and Canadian interest rates narrows. That could make currency-hedged instruments like Canadian Depositary Receipts (CDRs) more appealing to Canadian investors, said Elliot Scherer, global head of the Wealth Solutions Group at CIBC Capital Markets.
Canadian dollar heads for biggest monthly gain in a year on rate hike bets
“Generally, lower rates are good for equity valuations. So I think, generally, getting exposure to U.S. equities at a time when interest rates in the U.S. are coming down will help,” he said. If U.S. rates fall, the Canadian dollar might rally relative to its U.S. counterpart, he added.
“That might be a good time to have a hedge on because if you don’t have a hedge on, when the U.S. dollar depreciates then your returns will be eroded.”
Despite chills in the Canada-U.S. relationship, Canadian investors have remained heavy buyers of U.S. stocks. They bought a net $84.2-billion worth of U.S. equity and investment fund shares last year, more than double the $41.8-billion total in 2024.
Introduced in 2021 and issued by CIBC Capital Markets and BMO Global Asset Management, CDRs are Canadian-dollar instruments that allow investors to trade global-listed companies on Canadian exchanges. While CDRs are available for some listed companies in Japan and Europe, nearly three-quarters of the more than 160 CDRs currently tradeable are for U.S. firms.
A CDR reflects a changing number of shares in a listed firm, with the specific ratio adjusted to account for currency moves. David Hudson, head of structured solutions at BMO Global Asset Management, said the instruments are designed "so Canadians can gain economic exposure to a foreign company’s share price performance, while reducing the risk associated with currency fluctuations."
That reduced risk comes at a cost. Canadian Imperial Bank of Commerce says that investors pay an average of about 0.6 per cent a year to hedge against currency moves. If the Canadian dollar weakens against the currency of an underlying company’s home market, the CDR’s hedge can also reduce an investor’s overall gain.
CDRs are not the only assets that provide currency-hedged equities exposure for Canadian investors. Major ETF issuers, including BlackRock, Vanguard and Bank of Montreal, for example, provide Canadian dollar-hedged index ETFs tracking major U.S. indexes.
Pierre-Benoît Gauthier, vice-president of investment strategy at IG Wealth Management, said if one accepts the market consensus on the Canadian and U.S. policy outlook, a hedge such as that provided by a CDR “could be interesting.” While markets are pricing in about 1½ interest-rate increases in Canada this year, expectations in the U.S. are for rates to remain flat.
However, Mr. Gauthier cautioned that he found the market consensus implausible.
“I cannot find a single way in which the Canadian economy is in better shape than the U.S. economy on any metric out there,” he said. “It’s almost impossible to see a world where Canada hikes and the U.S. eases.”
While the Canadian dollar used to more closely track movements in global oil prices, Mr. Gauthier said that relationship had weakened since the start of the COVID-19 pandemic. He also questioned whether the Bank of Canada realistically sees higher interest rates as an effective tool.
“I’m sure in the back of their head they’re thinking, ‘If I raise rates right now, does it really fight inflation?’ Because it doesn’t open the Strait of Hormuz.”
Mr. Gauthier said investors who disagree with the prevailing expectations may find opportunities in fixed income and unhedged foreign investments. Bond yields could drop, lifting prices, as the market readjusts expectations of policy rate rises.
“However, I wouldn’t make too big of a deal out of this because we’re talking a couple per cent,” he said. “We’re not seeing a huge dislocation.”