- The trade-weighted USD looks stretched after gaining about 20% over the last two years. The last time the greenback saw a similar surge was in 1997, and that didn’t end up well for the global economy. The Fed will take note of risks, both domestic and global, associated with its policies and is therefore likely to move very slowly on interest rates. The unwinding of the massive speculative long USD positions could help bring the dollar back to earth.
- There are encouraging signs that the European Central Bank’s aggressive policies are starting to bear fruit. Credit channels in the Eurozone are slowly being unblocked as evidenced by improving household credit and business loans, the latter even managing to grow on a year-on-year basis for the first time since 2012. So, unless inflation disappoints, the ECB may want to adopt a wait and see approach. The common currency could slip over the near term on unfavourable yields, but we remain of the view it will recover later in the year particularly if the USD gives back some of its outsized gains of the past couple of years.
- While the Canadian dollar has sunk faster than we had anticipated due to a further slide in oil prices, we continue to expect it to stabilize in 2016. Besides an expected Fed-induced weakening of the USD, the loonie could also benefit from commodities which arguably have more upside than downside following the recent collapse. We expect USDCAD to come close to the lower end of the 1.30-1.40 trading range in 2016. The major downside risk to that call, besides oil prices, is Bank of Canada policy which could potentially be loosened further, particularly if the employment outlook sours.
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