MARKET TONE
Broad US dollar (USD) strength has moderated a little since April when the Bloomberg dollar index (BBDXY) peaked around 1271. The rising trend in the USD through Q1 and early Q2 was supported by the rebound in US rates and it is no coincidence that the peak in the BBDXY coincided with the peak in US short rates around the 5% level as markets reacted to stronger-than-expected inflation and employment data. Progress on inflation remains glacial, notwithstanding the lower-than-expected CPI data for May, but signs of some slowing in the US economy and the labour market may start to weigh on US yields and the USD moving forward.
Federal Reserve (Fed) policymakers remain cautious on the rate outlook. The latest FOMC decision saw rates left unchanged, as expected, but did reveal a shift in Fed thinking on the rate outlook. The dot plot showed that policymakers only expect one 25bps rate cut this year now, down from the three cuts implied in the March round of estimates. A little more (relative to the March estimates) easing was reflected in the view for 2025, however. Chairman Powell reiterated that the dots were not a “plan” and can “adjust”. Swaps pricing suggest markets continue to bet on closer to two rate cuts emerging over the rest of the year.
As markets have reined back Fed rate cut expectations, expectations for lower rates beyond North America have moderated as well. Inflation is proving somewhat sticky elsewhere, growth momentum is improving moderately and central bankers have tacitly acknowledged that slower rate cuts in the US may affect their own pace of easing. Short-term interest rate differentials which were moving strongly in the USD’s favour earlier this year have moderated. With interest rates unlikely to move higher in the US now, it appears that yield support for the USD peaked in the spring. High for longer US rates means a high—but not necessarily higher—for longer USD. Absent other drivers, the USD bull run has likely peaked.
We continue to anticipate some moderation in USD strength in H2 as the Fed gets closer to easing interest rates and markets look ahead to 2025 when the US economy’s growth advantage is likely to narrow. Clearly, however, there are risks to the outlook. Geo-political tensions remain evident. Although shipping and freight costs continue to rise as a result of Red Sea tensions, these risks appear manageable for markets at this point. Note that oil prices recently fell to their lowest since February. Heightened volatility in other asset markets could affect the USD’s performance. Equity markets are nearing the time of the year that is typically associated with a period of softness. And, of course, the US presidential election is likely to figure as a factor for investors into H2 when candidate Trump’s trade policies may come under greater scrutiny.
The Canadian dollar (CAD) is soft and, following the Bank of Canada (BoC) initiating its easing cycle this month, it looks poised to remain soft. The start of the rate cut cycle came a little earlier than we had expected and the dovish tone of the policy statement suggests that further rate cuts will follow fairly quickly. We now anticipate a further three 25bps cuts from the BoC over the next three policy decisions for a total of 100bps of cuts this year. Therefore, we have adjusted our forecast for the CAD lower and expect USDCAD to trade at 1.38 in the next few months before edging a little higher to 1.36 at year-end when the Fed easing cycle should be underway.
In Europe, the Swiss National Bank (SNB), Riksbank and European Central Bank (ECB) have all initiated their own easing cycles now. The ECB’s decision was well-telegraphed by rate setters and was easily digested by the euro (EUR). The decision to cut rates was not unanimous (there was one dissenter) and expectations for quick, additional easing were firmly dampened by a cautious outlook from President Lagarde. Data released just after the rate decision showing a pickup in worker compensation in Q1 (to 5.1% Y/Y) might explain policymakers’ reticence about providing clearer guidance on rates. Higher wage growth risks stoking second round inflation pressures. Further ECB easing may have to wait for signs that wage pressures are clearly moderating which suggests September at the earliest. The outlook for somewhat slower (than expected) rate cuts should provide the EUR with some support against the prevailing strength of the USD on EURUSD dips back to the 1.07 zone.
Sterling (GBP) took UK Prime Minister Sunak’s decision to call a snap election for July 4th in its stride. A general election was due by early 2025. An earlier election amounts to a tacit admission that key concerns for voters (health, education, immigration) are not going to improve for the ruling Conservative party in the next few months. The Conservatives were at a significant disadvantage in the opinion polls before the election call and early campaigning has made a bad situation worse for them. Labour appears to be heading for a “landslide” win. After 14 years of sometimes crass and reckless Tory leadership, markets are at ease with the prospect of a Labour win. Brexit is a low-priority consideration for UK voters right now but a Labour government could forge a reset of UK relations with Europe which would be a mild positive for the GBP in the medium term.
Recent elections in India (where PM Modi’s BJP lost its majority) and Mexico, where AMLO’s anointed successor Claudia Sheinbaum and the Morena party gained more support than expected, injected volatility and uncertainty into local markets. Mexican peso (MXN) volatility was amplified by carry trades getting squeezed out as investors dumped the MXN in response to the election results. Strong gains for AMLO’s Morena appear to have paved the way for constitutional reforms. Elevated US interest rates are helping keep regional Latam currencies on the defensive overall but the MXN’s sharp fall in early June leaves it an underperformer versus its Pacific Alliance peers after a sustained period of outperformance.
Data from Japan’s Ministry of Finance indicated the authorities spent a record USD62bn supporting the yen (JPY) through late April and into May. Some of that intervention appears to have been financed by the sale US Treasury securities held by the Bank of Japan (BoJ). The JPY remains soft but the aggressive support for the currency and the potential for the BoJ to make further, modest adjustments to monetary policy should help stabilize the JPY around the recent low (160).
Shaun Osborne, Canada 416.945.4538
FX FORECASTS
CAD FX FORECASTS
FEDERAL RESERVE & BANK OF CANADA MONETARY POLICY OUTLOOK
FEDERAL RESERVE—SEPTEMBER IS ‘LIVE’
Scotiabank Economics continues to expect the Federal Reserve to stay on hold until September when we think the Committee could deliver a first rate cut. We expect 50bps of cuts this year, with the next one at the December meeting. At present, we think that the policy rate will be gradually reduced to 3.5% by the end of 2025.
A lot has to go right for the FOMC to feel comfortable easing by the September meeting. Nascent evidence of a sharp softening of inflationary pressure arrived in the May CPI report when core CPI landed at just 0.16% m/m SA along with soft core services inflation and further improvement in terms of a falling breadth of price increases. This will probably translate into a very soft core PCE reading at the end of June. There are three more CPI and three more core PCE readings before the September decision which probably explains why 8 on the Committee think -50bps of cuts are possible this year while 7 think -25bps. It will all come down to watching the nearer term data.
BANK OF CANADA—100BPS OF CUTS THIS YEAR
Scotiabank Economics increased its forecast easing this year to 100bps from 75bps after the latest Bank of Canada announcement. Our best estimate at this point is that the BoC will be on a path toward a 3¼% policy rate trough by next summer, thereby maintaining a mildly restrictive stance relative to our estimated neutral rate. The Canada curve is getting richly priced for this expectation.
Since this time last year, we were forecasting a 25bps cut at this June’s meeting but pushed that out to Q3 earlier this year. We did that because the economy is tracking materially better than the BoC feared at the start of the year, and because in early May Governor Macklem said he wanted ‘months’ of additional evidence before deciding to cut.
Nevertheless, when he violated his own forward guidance and cut a few weeks later it was clear that Macklem had seen enough evidence and was in a bigger hurry to jump in ahead of the Federal Reserve. This was not narrative changing for us as opposed to a forecast tweak given Macklem’s new stance. We remain concerned about how the economy and inflation risk will evolve as further easing unfolds.
Derek Holt, Canada 416.863.7707
NORTH AMERICA
MAJOR CURRENCIES
MAJOR CURRENCIES (continued...)
LATIN AMERICA
DISCLAIMERS
FOREIGN EXCHANGE STRATEGY
This publication has been prepared by The Bank of Nova Scotia (Scotiabank) for informational and marketing purposes only. Opinions, estimates and projections contained herein are our own as of the date hereof and are subject to change without notice. The information and opinions contained herein have been compiled or arrived at from sources believed reliable, but no representation or warranty, express or implied, is made as to their accuracy or completeness and neither the information nor the forecast shall be taken as a representation for which Scotiabank, its affiliates or any of their employees incur any responsibility. Neither Scotiabank nor its affiliates accept any liability whatsoever for any loss arising from any use of this information. This publication is not, and is not constructed as, an offer to sell or solicitation of any offer to buy any of the currencies referred to herein, nor shall this publication be construed as an opinion as to whether you should enter into any swap or trading strategy involving a swap or any other transaction. The general transaction, financial, educational and market information contained herein is not intended to be, and does not constitute, a recommendation of a swap or trading strategy involving a swap within the meaning of U.S. Commodity Futures Trading Commission Regulation 23.434 and Appendix A thereto. This material is not intended to be individually tailored to your needs or characteristics and should not be viewed as a “call to action” or suggestion that you enter into a swap or trading strategy involving a swap or any other transaction. You should note that the manner in which you implement any of the strategies set out in this publication may expose you to significant risk and you should carefully consider your ability to bear such risks through consultation with your own independent financial, legal, accounting, tax and other professional advisors. Scotiabank, its affiliates and/or their respective officers, directors or employees may from time to time take positions in the currencies mentioned herein as principal or agent, and may have received remuneration as financial advisor and/or underwriter for certain of the corporations mentioned herein. Directors, officers or employees of Scotiabank and its affiliates may serve as directors of corporations referred to herein. All Scotiabank products and services are subject to the terms of applicable agreements and local regulations. This publication and all information, opinions and conclusions contained in it are protected by copyright. This information may not be reproduced in whole or in part, or referred to in any manner whatsoever nor may the information, opinions and conclusions contained in it be referred to without the prior express written consent of Scotiabank.
™ Trademark of The Bank of Nova Scotia. Used under license, where applicable. Scotiabank, together with “Global Banking and Markets”, is a marketing name for the global corporate and investment banking and capital markets businesses of The Bank of Nova Scotia and certain of its affiliates in the countries where they operate, all members of the Scotiabank group and authorized users of the mark. The Bank of Nova Scotia is incorporated in Canada with limited liability and is authorised and regulated by the Office of the Superintendent of Financial Institutions Canada. The Bank of Nova Scotia and Scotiabank Europe plc are authorised by the UK Prudential Regulation Authority. The Bank of Nova Scotia is subject to regulation by the UK Financial Conduct Authority and limited regulation by the UK Prudential Regulation Authority. Scotiabank Europe plc is authorised by the UK Prudential Regulation Authority and regulated by the UK Financial Conduct Authority and the UK Prudential Regulation Authority. Details about the extent of The Bank of Nova Scotia's regulation by the UK Prudential Regulation Authority are available on request. Scotiabank Inverlat, S.A., Scotia Inverlat Casa de Bolsa, S.A. de C.V., and Scotia Inverlat Derivados, S.A. de C.V., are each authorized and regulated by the Mexican financial authorities. Not all products and services are offered in all jurisdictions. Services described are available in jurisdictions where permitted by law.
SCOTIABANK ECONOMICS
This report has been prepared by Scotiabank Economics as a resource for the clients of Scotiabank. Opinions, estimates and projections contained herein are our own as of the date hereof and are subject to change without notice. The information and opinions contained herein have been compiled or arrived at from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness. Neither Scotiabank nor any of its officers, directors, partners, employees or affiliates accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or its contents.
These reports are provided to you for informational purposes only. This report is not, and is not constructed as, an offer to sell or solicitation of any offer to buy any financial instrument, nor shall this report be construed as an opinion as to whether you should enter into any swap or trading strategy involving a swap or any other transaction. The information contained in this report is not intended to be, and does not constitute, a recommendation of a swap or trading strategy involving a swap within the meaning of U.S. Commodity Futures Trading Commission Regulation 23.434 and Appendix A thereto. This material is not intended to be individually tailored to your needs or characteristics and should not be viewed as a “call to action” or suggestion that you enter into a swap or trading strategy involving a swap or any other transaction. Scotiabank may engage in transactions in a manner inconsistent with the views discussed this report and may have positions, or be in the process of acquiring or disposing of positions, referred to in this report.
Scotiabank, its affiliates and any of their respective officers, directors and employees may from time to time take positions in currencies, act as managers, co-managers or underwriters of a public offering or act as principals or agents, deal in, own or act as market makers or advisors, brokers or commercial and/or investment bankers in relation to securities or related derivatives. As a result of these actions, Scotiabank may receive remuneration. All Scotiabank products and services are subject to the terms of applicable agreements and local regulations. Officers, directors and employees of Scotiabank and its affiliates may serve as directors of corporations.
Any securities discussed in this report may not be suitable for all investors. Scotiabank recommends that investors independently evaluate any issuer and security discussed in this report, and consult with any advisors they deem necessary prior to making any investment.
This report and all information, opinions and conclusions contained in it are protected by copyright. This information may not be reproduced without the prior express written consent of Scotiabank.
™ Trademark of The Bank of Nova Scotia. Used under license, where applicable.
Scotiabank, together with “Global Banking and Markets”, is a marketing name for the global corporate and investment banking and capital markets businesses of The Bank of Nova Scotia and certain of its affiliates in the countries where they operate, including; Scotiabank Europe plc; Scotiabank (Ireland) Designated Activity Company; Scotiabank Inverlat S.A., Institución de Banca Múltiple, Grupo Financiero Scotiabank Inverlat, Scotia Inverlat Casa de Bolsa, S.A. de C.V., Grupo Financiero Scotiabank Inverlat, Scotia Inverlat Derivados S.A. de C.V. – all members of the Scotiabank group and authorized users of the Scotiabank mark. The Bank of Nova Scotia is incorporated in Canada with limited liability and is authorised and regulated by the Office of the Superintendent of Financial Institutions Canada. The Bank of Nova Scotia is authorized by the UK Prudential Regulation Authority and is subject to regulation by the UK Financial Conduct Authority and limited regulation by the UK Prudential Regulation Authority. Details about the extent of The Bank of Nova Scotia's regulation by the UK Prudential Regulation Authority are available from us on request. Scotiabank Europe plc is authorized by the UK Prudential Regulation Authority and regulated by the UK Financial Conduct Authority and the UK Prudential Regulation Authority.
Scotiabank Inverlat, S.A., Scotia Inverlat Casa de Bolsa, S.A. de C.V, Grupo Financiero Scotiabank Inverlat, and Scotia Inverlat Derivados, S.A. de C.V., are each authorized and regulated by the Mexican financial authorities.
Not all products and services are offered in all jurisdictions. Services described are available in jurisdictions where permitted by law.