- Based on its latest meeting minutes and recent speeches by its Governors, the Fed seems keen to raise interest rates this summer. Its concerns about low interest rates for too long threatening the stability of financial markets (via asset bubbles and risky behaviour) are valid to some extent. But international developments may restrain the FOMC’s abilities to hike. Even assuming Brexit is avoided after the June 23rd referendum in the UK, more stimulus can be expected from both the European Central Bank and the Bank of Japan, which would likely to push the US dollar higher and tighten financial conditions in the US. Moreover, domestic US economic conditions may not be conducive to tighter policy. The observed labour market deceleration over the last couple of months is a worrying trend, albeit not surprising to us considering weak corporate profits and poor productivity in the US. Our view that the USD will temporarily be losing steam against other major currencies over the next few months is based on the assumption the Fed will delay rate hikes to the last quarter of the year.
- While the euro and yen could make gains against the USD over the next couple of months, they should remain vulnerable to loose central bank policies over the longer term as both the Eurozone and Japan grapple with tepid economic growth and the persistent threat of deflation.
- If, as we expect, the Fed is unable to hike in the summer, the Canadian dollar and commodities could get a lift over the near term. But given the large current account deficit and hence the dependence of foreign capital flows, a sudden C$ depreciation cannot be ruled out, more so if there is a negative turn in sentiment about Canada’s economic prospects. We expect USDCAD to be in the 1.25-1.35 trading range over the next 12 months.
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