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FX Forecasts

The US Dollar Wasn’t Able to Hold On to Its April Gains

Markets are reluctant to price in major divergences in monetary policy

May 30, 2024
Jimmy Jean, Vice-President, Chief Economist and Strategist • Hendrix Vachon, Principal Economist

Highlights

  • Changing monetary policy expectations are still fuelling exchange rate movements. Until early this spring, investors were focused mainly on when interest rate cuts might start as it became clear that there could be significant timing differences between the US Federal Reserve (Fed) and most other major central banks. Since then, attention has shifted to the total number of upcoming rate cuts, and the markets seem hesitant to bet on a major discrepancy.
  • At the time of writing, money market futures were pricing roughly one and a half rate cuts from the Fed this year. Market expectations were for two and a half cuts in the eurozone, which isn't a terribly large divergence from the Fed. The Bank of Canada (BoC) was also expected to cut rates two and a half times. The markets are maintaining a high probability that both the European Central Bank (ECB) and the BoC will announce an initial rate cut in June. In other words, the current expectation is that rates will come down very gradually over the rest of the year in both the eurozone and Canada. The Bank of England (BoE) isn't likely to move any faster. Now that a general election has been called, there's little chance that the first cut will happen in June. As things stand, markets have priced in one and a half BoE cuts by the end of the year.
  • Recent economic data has given people reason to believe there will be less divergence in the monetary policies of the world's main central banks. In the US, the numbers point to a slowdown after several quarters of economic vigour. Meanwhile, recent data indicate that growth is picking up in the eurozone and the UK, boosting the euro as well as the pound. Eurozone negotiated wage growth also accelerated in the first quarter. The ECB had been keenly waiting for this information, though with hopes that wage growth would slow.
  • Canada's economic data remains gloomy, and several inflation measures have continued their downward trajectory. Job creation was strong in April, but the average gains in recent months were still outpaced by labour force growth. The job market is therefore becoming more balanced as the number of vacancies declines. Overall, the Canadian dollar managed to appreciate a little in May and is currently hovering around CA$1.365/US$. That said, both the euro and the pound made stronger gains.
  • The yen and the Swiss franc are having a harder time appreciating against the US dollar. Japan's economic data has been disappointing, with real GDP falling significantly. The country's inflation rate also fell, reducing the need to immediately follow last March's initial interest rate hike with further increases. The markets are currently betting that Japan's key interest rate will go up 0.3 percentage points by the end of the year. Over in Switzerland, inflation remains low, and the Swiss National Bank has already announced a rate cut.

Main Factors to Watch

  • We expect to see more monetary policy divergence than what the markets are currently anticipating. Consequently, we believe the US dollar could recover against many currencies this summer, then subsequently weaken if US inflation comes down enough and Fed rate cuts become imminent. We expect two interest rate cuts in the US in late 2024. Also, the US dollar shouldn’t be buoyed by a safe-haven effect later in 2024 or next year since many countries will likely see improved economic growth and risk appetite isn’t expected to fall.
  • In the eurozone, people will be looking out for the inflation data released at the end of May, but our attention will be turned to the ECB meeting on June 6. Although a rate cut now seems very likely, it will be interesting to see what indications the central bank provides on future decisions. The euro will likely depreciate if the ECB sends clear signals that further rate cuts are coming in short order. As things stand, we expect four ECB rate cuts by the end of the year.
  • It's a similar story for the Canadian dollar. Our scenario includes four cuts in 2024, with the first occurring in June and another following in July. If this sequence materializes, the Canadian dollar exchange rate could reach CA$1.40/US$ sometime this summer. In fact, the effect could even be amplified if Canadian economic data continues to be weak and convincing progress on US inflation remains scarce.

Main Exchange Rates

Currency Market

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