- Jimmy Jean, Vice-President, Chief Economist and Strategist • Hendrix Vachon, Principal Economist
FX Forecasts
A Rebound by the Greenback Is Unlikely with the Fed More Focused on the Economy
September 25, 2024
Highlights
- The Federal Reserve (Fed) kicked off the US monetary easing cycle with a jumbo 50‑basis-point cut. This decision was deemed necessary, given the faster‑than‑expected progress on inflation—and the recent downside risks that have appeared for the economy. The Fed doesn't want to see the US economy or labour market slow any further.
- The rate cut had little impact on the US dollar, which had already depreciated substantially in the weeks leading up to the Fed meeting. Most projections had called for the Fed to announce at least one 50‑basis‑point cut by the end of the year. Fed officials are now signalling further 25‑basis‑point cuts at their upcoming meetings. This didn’t trigger any further depreciation, since the markets were already anticipating these cuts, if not larger ones.
- Currencies from several emerging economies have benefitted from lower US interest rates. Capital inflows to emerging economies tend to fluctuate in response to US monetary policy. As the Fed’s move should support the economy, investor risk appetite has grown and it should now be even easier to attract capital to these countries.
- This optimism is also pushing up commodity prices, but the gains remain limited overall. This is probably one of the reasons the Canadian dollar is underperforming compared to other currencies. China's economy is still on a downtrend, fueling fears of weak demand for commodities. It is uncertain whether the recent economic stimulus measures announced in China will be effective. Oil prices have also stayed lacklustre, held back by an abundant supply.
- But this isn't the only factor weighing on the Canadian dollar. Since the start of this monetary easing cycle, the Bank of Canada has loosened its monetary policy further than any other major central bank. The Canadian economy also seems to be struggling more than the others, with a sharp decline in real GDP per capita and rising unemployment. Inflation is also lower in Canada, and it's increasingly likely that the Bank will call for a 50‑basis‑point cut at its next meeting.
- Persistent inflation in Europe continues to limit rate cut expectations. This is giving a boost to several currencies in the region. The pound sterling is currently above US$1.33, its highest level since March 2022. The euro recently tested US $1.12 for the first time in a year.
- Japan's monetary policy is in even greater contrast, with the central bank instead in "rate hike mode" after staying on hold in 2022 and 2023. Inflation spent decades struggling to stay in positive territory, but now seems to be holding above 2%. The 3‑month annualized change in inflation less fresh food and energy accelerated, hitting 3.4% in August. Along with the US rate cut, the context has become more favorable for the yen which has appreciated dramatically. It's now trading at ¥143/US$, versus ¥160/US$ in July.
Main Factors to Watch
- The US dollar isn't known for making gains when the global economy is thriving. It's known for being a safe‑haven currency—its value rises in times of fear. Continued rate cuts in the US should help the country avoid an overly sharp economic slowdown. We therefore don't expect much from the greenback in the quarters ahead. However, our forecasts do not reflect the potential consequences of a Trump victory. Should he take office and implement protectionist measures, the US dollar could instead appreciate. Our foreign exchange forecasts would then need to be revised.
- Continued economic expansion in the United States would be good news for Canada and the Canadian dollar. All the same, the Canadian economy will face major headwinds. Population growth is expected to slow, and even with the rate cuts, many borrowers are facing mortgage renewals with higher interest rates. We're moderately optimistic about the Canadian economy, which will limit the potential for a stronger loonie. However, a rebound in some commodity prices should help the Canadian dollar, as should the narrower interest rate spreads with the United States. The pair is currently trading at C$1.35/US$ and we expect the exchange rate to approach C$1.33/US$ next year.
- The economic situation in Europe also bears watching. Higher‑for‑longer interest rates could hurt the economy. The latest PMI indicators point to an upcoming slowdown. For now, central banks in the region are still cautious about the pace of interest rate cuts, but this could change rapidly if more disinflationary pressures materialize. It may be more difficult for the pound and the euro to make further gains in the coming months.
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