Can the U.S. Dollar Only Go Down from Here?

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FEBRUARY 19, FX FORECASTS Can the U.S. Dollar Only Go Down from Here?

ff It is difficult to expect that the euro will appreciate much as long as the issue of economic divergence on both sides of the Atlantic persists.

ff Assuming a no-deal Brexit will be avoided, but that the uncertainty surrounding this issue will linger on to some extent, the pound could appreciate slightly by the end of the year.

1 FEBRUARY 19, FX FORECASTS Can the U.S. Dollar Only Go Down from Here? HIGHLIGHTS ff As fears could last longer elsewhere, a new lull in the United States could help the greenback, all the more so if the expectation of a new round of interest rate hikes were to reappear. ff It is difficult to expect that the euro will appreciate much as long as the issue of economic divergence on both sides of the Atlantic persists. In the short term, the euro could further depreciate against the U.S. dollar. If the German economy regains some strength, the euro could re-embark on an upward trend beginning around mid. ff Assuming a no-deal Brexit will be avoided, but that the uncertainty surrounding this issue will linger on to some extent, the pound could appreciate slightly by the end of the year. ff The Canadian dollar could appreciate to around US$.77. This underpins slightly higher oil prices as well as the resumption of monetary tightening in Canada in the second half of the year. ff The yuan had been depreciating significantly in as the threat of U.S. protectionism escalated. More recently, it was tending to appreciate, which seems in keeping with the hope that the trade tensions between China and the United States would ease. CONTENTS Highlights and Editorial... 1 Canadian Dollar... 3 Euro... 4 #1 BEST OVERALL FORECASTER - CANADA The U.S. dollar tends to appreciate primarily when uncertainty rises and investors appetite for risk falls. As it so happens, since the beginning of the year, the U.S. currency still seems attractive despite the return of a certain appetite for risk. After losing ground at the beginning of the year, the U.S. dollar effective exchange rate index (DXY) is sitting higher than at the end of (graph 1). Is this sustainable? GRAPH 1 Despite the market rebound, the U.S. dollar remains attractive U.S. dollar effective exchange rate (DXY)* Index * Based on a basket of currencies that includes the Canadian dollar, euro, pound, yen, Swiss franc and Swedish krona. A Strong Performance, but Far from Widespread Analyzing the trend of the U.S. dollar using only the DXY index can prove to be deceptive. This index is based solely on a basket holding no more than a few currencies, i.e., the Canadian dollar, euro, pound sterling, yen, Swiss franc and Swedish krona. In fact, since the beginning of the year, the U.S. dollar has depreciated against several currencies, most notably those of emerging countries (graph 2 on page 2). This clearly demonstrates that the increased appetite for risk globally has weighed on the U.S. dollar. On the other hand, it has appreciated against other currencies, including the euro, yen, Swiss franc and British Pound and Swiss Franc... Yen and Australian Dollar... 6 Emerging Currencies... 7 Chinese yuan., Mexican peso, Brazilian real Tables... 8 François Dupuis, Vice-President and Chief Economist Mathieu D Anjou, Deputy Chief Economist Hendrix Vachon, Senior Economist Desjardins, Economic Studies: or , ext desjardins.economics@desjardins.com desjardins.com/economics NOTE TO READERS: The letters k, M and B are used in texts and tables to refer to thousands, millions and billions respectively. IMPORTANT: This document is based on public information and may under no circumstances be used or construed as a commitment by Desjardins Group. While the information provided has been determined on the basis of data obtained from sources that are deemed to be reliable, Desjardins Group in no way warrants that the information is accurate or complete. The document is provided solely for information purposes and does not constitute an offer or solicitation for purchase or sale. Desjardins Group takes no responsibility for the consequences of any decision whatsoever made on the basis of the data contained herein and does not hereby undertake to provide any advice, notably in the area of investment services. The data on prices or margins are provided for information purposes and may be modified at any time, based on such factors as market conditions. The past performances and projections expressed herein are no guarantee of future performance. The opinions and forecasts contained herein are, unless otherwise indicated, those of the document s authors and do not represent the opinions of any other person or the official position of Desjardins Group. Copyright, Desjardins Group. All rights reserved.

2 GRAPH 2 The U.S. dollar fell against the currencies of several emerging countries Change in the U.S. dollar against the major currencies of advanced and emerging countries* Sweden Switzerland India Argentina Euro zone Korea Japan Taiwan Turkey Norway United Kingdom Australia South Africa Mexico China Malaysia Canada Indonesia Brazil Russia Thailand In % * Since the beginning of the year. Swedish krona, or four of the six currencies included in the DXY index. The challenges facing the European currencies are nothing new, given the more evident economic uncertainty in this part of the world. The slowdown in economic growth in Europe is already fairly obvious (graph 3). Italy is officially in recession, and Germany barely avoided joining it in the fourth quarter of. The lack of any signs of improvement is not helping, and not to mention other threats in the short term such as the social tensions in France involving the yellow vests, the approaching deadline to reach an agreement on Brexit, and the customs tariffs that the Trump administration could impose on European cars. The United States Must Remain Worry Free Until just recently, two major threats hung over the U.S. economy: an escalation of the protectionist measures against China and a new government shutdown. These two threats have decreased considerably, which, in relative terms, can help the U.S. dollar, especially against the currencies of countries where the threats remain high. That being said, all is not sunshine and roses for the U.S. economy, which has had its share of negative data recently. In particular, retail sales and industrial production suggest economic activity will slow down even more in the short term (graph 4). There are also doubts about the expected positive impact of tax refunds in the first half of the year. Many expected that last year s tax reform would translate into bigger refunds, but this doesn t seem to have spread across the board to include all U.S. taxpayers. GRAPH 4 Worst drop in retail sales excluding motor vehicles and gasoline since the last recession Retail sales excluding motor vehicles and service stations Monthly variation in % Sources: U.S. Census Bureau and Desjardins, Economic Studies GRAPH 3 Real GDP throughout Europe clearly fell in Real GDP in * Quarterly annualized variation in % U.S. U.K. Euro zone Germany Italy Sweden * Desjardins forecast for the fourth quarter in the United States and European Commission forecast for the fourth quarter in Sweden. Therefore, local concerns seem to be the primary reason for the greenback s strong performance against some currencies. In the case of the yen, this appears to be related mostly to the fact that it is also acting as a safe-haven currency at a time of high market volatility. Therefore, the current lull is consistent with a weaker yen. Should fears about the U.S. economy in the short term rise once again, this could only encourage the Federal Reserve to exercise even greater caution, as inflation does not seem to pose any threat. If some investors were to anticipate a drop in interest rates in the United States, the U.S. dollar could pay the price unless it were to benefit even more from safe-haven effect. That being said, our scenario for now sees the U.S. economy rebounding. As fears could last longer elsewhere, a new lull in the United States could help the greenback, all the more so if the expectation of a new round of interest rate hikes were to reappear. François Dupuis, Vice-President and Chief Economist Hendrix Vachon, Senior Economist FEBRUARY 2

3 Canadian Dollar (CAD) Waiting for Fairer Winds to Blow The Canadian dollar ended the year on a low note, but it quickly regained some of the ground lost. It is currently hovering around US$.7. This rise is in keeping with the return of a certain appetite for risk on the financial markets and the rebound in the price of oil and other commodities. Analyzed over a 3 month period, the Canadian dollar s momentum is back to neutral. However, the slight downward trend indicated by the exchange rate s 2 day moving average seems difficult to crack. The negative balance of the speculative positions shows that investors are continuing to bet on a depreciation. From a fundamental standpoint, the Canadian economy has shown pockets of weakness recently. The difficulties in exporting Western oil, among other things, have become more acute, forcing the Alberta government to cut production. The Canadian real estate market situation is also being closely watched. Moreover, the international economic context is worrying. The slowdowns in the United States, China and Europe threaten to cause a drop in Canadian exports and to discourage business investment. But it s not all doom and gloom. The labour market remains particularly strong in Canada. This is a good omen for consumption, especially since consumer confidence was up in January. Furthermore, the oil production cuts in Alberta seem to be working. The prices for Canadian-produced oil bounced back quickly, thereby limiting the financial losses for this economic sector. In addition, the pace of oil production could also pick up faster than initially expected. The Bank of Canada (BoC) downgraded its short-term economic growth forecasts and appears to be in less of a hurry to continue its monetary tightening. However, contrary to other central banks, the BoC is still indicating that more interest hikes are on the way. It is expecting economic activity to pick up as early as the second quarter, which could justify resuming monetary tightening later in the year. Forecasts: Currently, the threats are many, and our scenario is counting on these to subside during the coming quarters. If this were to happen, it could lift the Canadian dollar to around US$.77. This also underpins slightly higher oil prices as well as the resumption of monetary tightening in Canada in the second half of the year. CANADIAN DOLLAR C$/US$ (inverted scale) Canadian exchange rate 2-day moving average CANADIAN DOLLAR Momentum Quarterly variation in % CANADIAN DOLLAR Net speculative positions In % FEBRUARY 3

4 Euro (EUR) The Downside Risks Have Gained the Upper Hand The sudden rise in concern on financial markets in the final months of hit the euro, as investors preferred to seek shelter in the U.S. dollar, the Swiss franc and the yen. The change in the Federal Reserve s tone and the global stock market rebound temporarily helped the euro bounce back above US$1.1 at the beginning of, but downside pressure on the common currency quickly reappeared with the troubling political and economic developments in Europe. Fears of a global recession seem to be subsiding, as the economic statistics out of the U.S. remain strong overall, and the central banks have clearly signalled that they will be flexible and cautious. However, the euro zone s economic outlook continues to deteriorate, as the second half of was extremely difficult for several economies, and nothing points to a major improvement in the situation at the start of. At first, it was possible to think that the flagging growth in Germany was mostly a reflection of the temporary effects of the new vehicle emission standards on industrial output and motor vehicle sales, but this economy s problems appear to be more widespread today. The political and social situations in several countries, including Germany, France, Italy and Spain, are also troubling. As expected, the European Central Bank wound down its bond purchases at the end of. It feels that the fundamental factors underpinning growth in the euro zone are still in place, but it does acknowledge that the recent data were lower than anticipated and that the downside risks of the economy have increased. Against this backdrop, it appears unlikely that it will begin tightening the money supply before the end of the year, and it could soon announce new longterm funding operations to ensure the European financial markets are flush with liquidity. Forecasts: It is difficult to expect that the euro will appreciate much as long as the issue of economic divergence on both sides of the Atlantic persists. In the short term, the euro could further depreciate against the U.S. dollar. If the German economy regains some strength, the euro could re-embark on an upward trend beginning around mid. EURO US$/ Euro zone exchange rate 2-day moving average EURO Momentum Quarterly variation in % EURO Net speculative positions In % FEBRUARY 4

5 British Pound (GBP) Brexit Will Continue to Dominate Fluctuations in the Pound in the Short Term Like most of the currencies, the pound generally depreciated against the U.S. dollar in the closing months of before regaining some of the ground lost in the early weeks of. However, the developments surrounding Brexit have caused the pound to swing wildly, and everything indicates that this will continue as March 29, the date on which the United Kingdom is expected to officially leave the European Union, approaches. The post-brexit negotiations finally progressed at the end of, but the British government remains incapable of winning parliament s approval of the agreement concluded with European leaders, as the issue of the Irish border continues to pose a considerable obstacle. As most of the British members of parliament and European leaders seem to want to avoid a no-deal Brexit, the worst-case scenario should be avoided. For example, the March 29 deadline could be pushed back. The British economy is also showing signs of weakness, as the negative effects of the uncertainty surrounding Brexit seem to be growing. As a result, the Bank of England anticipates that real GDP in Britain will grow only 1.2% in, suggesting BRITISH POUND US$/ British exchange rate 2-day moving average that Britain s key rates will not rise any time soon. Assuming a no-deal Brexit will be avoided, but that the uncertainty surrounding this issue will linger on to some extent, the pound could appreciate slightly by the end of the year. Swiss Franc (CHF) The Franc Threatens to Remain in Demand The Swiss franc has played its role well as a safe haven in recent months. As a result, it appreciated against the euro and the dollar in the closing months of before falling back against these two currencies in January, when the stock markets rebounded. Hovering around 1.14, the franc remains relatively strong compared with the euro, and the Swiss monetary authorities will be watching very closely as the disturbing economic and political developments in the euro zone could lead to new upward pressure on the franc in the short term. The Swiss economy had a good year in, with real GDP growing around 2.%, but growth clearly slowed in the second half of the year. As inflation is expected to remain below 1.% in, nothing points to a tightening of the Swiss monetary policy this year. The Swiss franc is expected to remain strong in the short term, but it could drop in the second half of the year if international uncertainty eases. SWISS FRANC Exchange rate Franc/US$ Franc/ Franc/US$ (left) Franc/ (right) FEBRUARY

6 Yen (JPY) Further Depreciation Is Delayed amid Safe-Haven Effect As a safe-haven currency, the yen tends to appreciate at a time of uncertainty. The effect appeared greater at the end of because of the risk the trade war between China and the United States would escalate and the presence of other concerns relating more specifically to the U.S. economy. In the aftermath, the Japanese exchange rate temporarily reached 18/$US. Since then, it has been increasing slightly, as concerns have eased and investor appetite for risk is back on the rise. In the event the risks were to remain contained, it would seem likely that the yen would depreciate more, possibly to 113/$US. The Japanese economy remains fragile. Inflation is also struggling to accelerate, which is forcing the Bank of Japan to continue to purchase securities and maintain slightly negative key rates. The Japanese government also plans to raise the sales tax from 8% to 1% in October, which should slow down consumption. The impact of this tax increase risks being felt at the same time as construction for the Olympic Games in Tokyo in 22 begins to wind down. YEN /US$ (inverted scale) Japanese exchange rate 2-day moving average Australian Dollar (AUD) A Destiny Linked to the Situation in China After depreciating during most of, the Australian dollar is now stabilizing around US$.71. The trade tensions between the United States and China penalized the Australian currency. At the risk of damaging the Chinese economy, these trade tensions could have implications for the Australian economy in the form of a drop in exports and investment. China is the number one buyer of Australian exports. AUSTRALIAN DOLLAR US$/A$ Australian exchange rate 2-day moving average The Australian economy is still humming along relatively well for now. The labour market remains especially strong. The fact that the Reserve Bank of Australia (RBA) is keeping low interest rates as well as the government s increased spending on infrastructure are helping to compensate for the uncertainty shrouding the Chinese economy and the slowdown in the housing market. House prices are down in several Australian cities. Demand for mortgages is also low. Support from the RBA and the government may prove necessary for some time to come. The upside potential of the Australian dollar seems limited in the short term FEBRUARY 6

7 Emerging Currencies A Good Start to the Year CHINESE YUAN (CNY) The yuan had been depreciating significantly in as the threat of U.S. protectionism escalated. More recently, it was tending to appreciate, which seems in keeping with the hope that the trade tensions between China and the United States would ease. This improvement could quickly fade should the current trade negotiations fail and new customs tariffs be announced. Moreover, the downward trend in the Chinese economy s growth is favouring the adoption of expansionist policies. These policies are expected to bring back some downward pressure on the yuan in. CHINESE YUAN Yuan/US$ MEXICAN PESO (MXN) After a difficult start to the fall, which caused the USD/MXN pair to hit roughly 2. pesos, the value of the Mexican currency soared in December in spite of the very negative sentiment in the financial markets. Thanks to good economic data and a reassuring budget introduced by the Andrés Manuel López Obrador government, the pair fell to roughly 19 pesos in early. However, the Mexican economic figures released since then have been mixed. This, combined with the financial difficulties of petroleum giant Pemex, applied downward pressure on the peso in recent weeks. The peso is expected to hover around its current level in the coming months, but a gradual appreciation is forecast later. Mexico s political situation could still keep the peso volatile. The Brazilian currency has appreciated slightly since the beginning of the year, helped by the Federal Reserve s more conciliatory tone and the increased appetite for risk. The new Brazilian president, Jair Bolsonaro, has promised significant reforms to stimulate the Brazilian economy, which is still struggling to recover from the crisis that shook the country in 21 and 216. After rising slightly in, inflation recently dropped back below the 4% mark. With the inflation target pegged at 4.2% in, the Central Bank of Brazil is not under pressure to tighten its monetary policy at this time. The real could appreciate in, especially if the Brazilian economy improves. However, a possible new round of volatility on the financial markets, or renewed expectations of key interest rate hikes in the United States, could limit how much the real appreciates MEXICAN PESO Peso/US$ Mexican exchange rate 2-day moving average BRAZILIAN REAL (BRL) Chinese exchange rate 2-day moving average BRAZILIAN REAL Real/US$ Brazilian exchange rate 2-day moving average FEBRUARY 7

8 TABLE 1 Currency market: Yields VARIATION (%) SPOT PRICE LAST 2 WEEKS COUNTRY CURRENCY* Feb month -3 months -6 months -1 year Higher Average Lower Americas Argentina peso Brazil real Canada (USD/CAD) Canada (CAD/USD) Mexico peso Asia and South Pacific Australia (AUD/USD) China yuan renminbi Hong Kong dollar India rupee Japan yen New Zeland (NZD/USD) South Korea won , , , , Europe Denmark krona Euro zone (EUR/USD) Norway kroner Russia ruble Sweden krona Switzerland swiss franc United Kingdom (GBP/USD) * In comparison with the U.S. dollar, unless otherwise indicated. Note: Currency table base on previous day closure. TABLE 2 Currency market: History and forecasts Q4 Q1f Q2f Q3f Q4f Q1f Q2f Q3f Q4f USD/CAD EUR/USD GBP/USD USD/CHF USD/JPY AUD/USD USD/CNY USD/MXN USD/BRL CAD/USD EUR/CAD GBP/CAD CAD/CHF CAD/JPY AUD/CAD CAD/CNY CAD/MXN CAD/BRL Effective dollar1 Canadian dollar U.S. dollar Euro British pound Swiss franc Yen Australian dollar Chinese yuan Mexican peso Brazilian real 22 Q3 END OF PERIOD U.S. dollar Canadian dollar Euro British pound Swiss franc Yen Australian dollar Chinese yuan Mexican peso Brazilian real f: forecasts; 1 Trade-weighted against major U.S. partners (1973 = 1). Sources: Datastream, Federal Reserve Board and Desjardins, Economic Studies FEBRUARY 8

Serious Doubts Remain despite Encouraging Signs

APRIL 18, 2019 ECONOMIC & FINANCIAL OUTLOOK Serious Doubts Remain despite Encouraging Signs #1 BEST OVERALL FORECASTER - CANADA HIGHLIGHTS ff The global economy and the volume of trade both remain fragile,