- Having repeatedly warned a rate hike was coming before year-end, the Fed now finds itself, after October’s no-change decision, with one last shot to save face. But with inflation nowhere to be seen and the economy likely to face headwinds next year, the upcoming tightening cycle is likely to be brief. Another potential negative for the USD is the likely inclusion of the Chinese yuan in the IMF’s Special Drawing Rights. So, while the USD has room to run over the near term thanks to perging monetary policy with the rest of the world, we believe it is close to peaking. We have, accordingly, adjusted our currency forecasts to reflect a weakening USD after 2016Q1.
- Across the Atlantic, inflation is also missing in action. At its October meeting, the European Central Bank made clear it is ready to expand stimulus if it gets confirmation that the timeline for inflation to return to its 2% target is being pushed back. New ECB staff projections are likely to show just that when they are presented in December, at which time we expect the central bank to either cut the already negative deposit rate or to increase the size of the QE program. That should take EUR/USD closer to 1.05 by early next year.
- Like other major currencies, the Canadian dollar faces further headwinds amidst USD strength over the near term. The Bank of Canada, cognizant of the importance of export-led growth, will do its part to keep the loonie grounded through its communications. It could downplay the economic rebound underway and stick to its message about enhanced uncertainties with regards to the ability of Canada to fully capitalize on strengthening US demand. But the eventual erosion of yield disadvantage could mean a comeback for the loonie by mid-2016. So, while USD/CAD should trade between 1.25-1.35 over the forecast horizon, we expect it to come close to the lower end of that range by the end of next year.
Stéfane Marion/Krishen Rangasamy