The US dollar continues to benefit from the divergence of monetary policy. The stronger U.S. economy has raised the probability of rate hikes by the Fed at a time when several other major central banks have seemingly adopted competitive devaluation strategies by not only increasing stimulus but also signalling their intent to continue on that path. So, the greenback has room to run over the near to medium term. That said, we expect a moderation in the rate of USD appreciation this year. Low inflation will cap the Fed's abilities to significantly tighten monetary policy, while some unwinding of the massive speculative long positions could also take some steam out of the greenback.
The European Central Bank's quantitative easing program, slated to start in March, is significant. While the ECB's balance sheet may not surpass the Fed's in absolute terms, it will do so in relative terms -- as a percentage of the size of the respective economies, the ECB's balance sheet will be larger than the Fed's. Such currency debasement policies should hurt the euro. Recall that the trade-weighted U.S. dollar sank 18% from peak to trough during the Fed's own QE program.
The Canadian dollar has lost more than 20% of its value against the US dollar in the last two years. That said, the loonie's decline hasn't been as drastic against other currencies considering competitive devaluations by other central banks. So, while the Bank of Canada said its surprise January rate cut was an ''insurance policy'' against downside risks to inflation and financial stability, the loonie's relative competitiveness and preservation of market share may also have been at the back of Governor Poloz's mind. We expect the BoC to deliver another rate cut at its March meeting, something that should keep the Canadian dollar under pressure over the near term. That's not the say the loonie will remain on a downtrend. A recovery in oil prices should help offset headwinds generated by unfavourable yields and provide some support to the Canadian dollar.
Stéfane Marion/Krishen Rangasamy.