Will the U.S. Dollar Finally Profit From the Interest Rate Hikes?

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OCTOBER 24, FX FORECASTS Will the U.S. Dollar Finally Profit From the Interest Rate Hikes? HIGHLIGHTS ff Greater investor confidence with respect to U.S. economic growth and continued monetary tightening should support the greenback.

25/US$) between now and the end of the year if the Canadian economic data are sufficiently good to prompt the Bank of Canada to announce another interest rate increase.

ff Upcoming announcements by the European Central Bank could lead to significant fluctuations in the value of the euro. Subsequently, developments at the Federal Reserve could be determining factors.

1 OCTOBER 24, FX FORECASTS Will the U.S. Dollar Finally Profit From the Interest Rate Hikes? HIGHLIGHTS ff Greater investor confidence with respect to U.S. economic growth and continued monetary tightening should support the greenback. ff The Canadian dollar s potential for appreciation appears weaker. Nevertheless, it could return to more than US$0.80 (under C$1.25/US$) between now and the end of the year if the Canadian economic data are sufficiently good to prompt the Bank of Canada to announce another interest rate increase. Unless there is a shock, such as the United States withdrawing from North American Free Trade Agreement (NAFTA), the loonie is expected to gain a few more cents in. ff Upcoming announcements by the European Central Bank could lead to significant fluctuations in the value of the euro. Subsequently, developments at the Federal Reserve could be determining factors. ff The peso significantly declined in value at the end of September to return to roughly 19 pesos. The NAFTA negotiations are expected to remain a determining factor for the peso in the coming months. ff Given that inflation reached 3% in September, the Bank of England is expected to announce at its meeting on November 2 that it will be raising its key rates, which could help the pound in the short term. Nonetheless, the underperforming British economy should weaken the pound in. CONTENTS Highlights and Editorial... 1 Canadian Dollar... 3 Euro... 4 #1 BEST OVERALL FORECASTER - CANADA The U.S. dollar has generally trended downwards since the beginning of the year. A new cyclical low was reached the first week of September; since then, the greenback has been showing signs of a rebound (graph 1). This is not that strange due to the fact that the markets believe a little more in a continuation of monetary tightening in the United States and in greater divergence in monetary policies. It remains to be seen if this will last. GRAPH 1 New signs of a rebound by the U.S. dollar since September DXY effective exchange rate Index Sources: Bloomberg and Desjardins, Economic Studies More Interest Rate Increases on the Horizon Investors expected the Federal Reserve (Fed) to reconsider pursuing its monetary tightening during its meeting in September. Certainly, tensions with North Korea and the difficult hurricane season have added some uncertainty, but, in the end, a significant majority of the Fed s leaders, i.e. 12 out of 16, still British Pound and Swiss Franc... 5 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, Senior Economist Jimmy Jean, Senior 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 felt that another 0.25% increase in the key rates was warranted between now and the end of the year, and that other hikes would probably follow in the coming years. Moreover, the Fed confirmed that it would begin to gradually reduce its balance sheet. The monetary tightening planned by the leaders of the Fed will depend on how the U.S. economy performs. The economy will have to remain strong to eventually generate more inflationary pressures. A weaker economy and inflation that remains below the target longer than anticipated could justify less monetary tightening. For now, several indicators, such as the consumer and business confidence indexes, suggest that the economy will stay the course for the next few months. If these indicators remain strong, the markets could expect more rate hikes in, which would support the U.S. dollar. A Changing of the Guard at the Fed Janet Yellen s term at the head of the Fed is coming to a close. It will be up to Donald Trump to reappoint her for another term or to find a successor. The latest changes at the top maintained a certain continuity with their predecessor. However, the list of candidates currently circulating suggests that a break could be coming. This would be the case, in particular, if Kevin Warsh or John B. Taylor were to be appointed. The U.S. monetary policy could become much more hawkish under either of them, which could help the greenback. It is not impossible that Janet Yellen may yet be reappointed. The markets would remain on familiar ground, yet still hesitate to anticipate several interest rate hikes ahead of time, which limits the U.S. dollar s potential for appreciation. Jerome Powell could prove to be the candidate with a vision similar to Janet Yellen s. As a member of the Federal Reserve Board of Governors since, he has always voted with Ben Bernanke and Janet Yellen. major economies. For example, the ECB is expected to buy fewer securities in, but the possibility of an interest rate hike and a reduction in the size of its balance sheet appears remote compared to what the Fed may do. The Threat of Protectionism The negotiations surrounding the North American Free Trade Agreement (NAFTA) are progressing slower than anticipated, and the threat of the United States pulling out is growing. This kind of outcome would have several consequences for the economy and financial markets, including exchange rates. We believe that a rise in U.S. protectionism, through the withdrawal from NAFTA and the introduction of new customs tariffs, may have a better chance of increasing the value of the U.S. currency. First of all, the uncertainty created would probably increase the demand for safe haven, such as the U.S. dollar. Next, the U.S. currency would profit from a reduction of the U.S. trade deficit thanks to the protectionist measures. The same would go for the U.S. economy if it was stimulated by a wave of investments and hiring to produce more goods locally. Inflationary pressures would be stronger and would justify accelerating monetary tightening. Inflation could also increase because of the higher costs for goods that would still be imported and difficult to replace. For now, our scenario does not foresee the abandonment of NAFTA, nor the imposition of major customs tariffs. The appreciation of the dollar that we do foresee in the short term essentially depends on greater investor confidence with respect to U.S. economic growth and continued monetary tightening. François Dupuis, Vice-President and Chief Economist Hendrix Vachon, Senior Economist Monetary Tightening Becoming Widespread Despite the continued monetary tightening in the United States, the impact on the U.S. dollar could be limited in the end because of expectations that the monetary conditions elsewhere in the world will also be tightened. In fact, this is what happened in. Since the spring, investors have been betting heavily on the European Central Bank (ECB) eventually beginning to reduce its securities purchase program, and then the euro and other European currencies gained in value. The Bank of Canada, which announced two consecutive interest rate hikes in the summer, helped the Canadian dollar to appreciate significantly. The Bank of England helped the pound this fall by opening the door to interest rate hikes. Our scenario is counting on a certain continuity in expectations on monetary tightening outside the United States. Nevertheless, we feel that there will be a noticeable difference between the level of tightening in the United States and in most of the other OCTOBER 2

3 Canadian Dollar (CAD) What Will the Bank of Canada Do? In early September, the Canadian dollar profited from the second straight key interest rate hike in Canada. This hike prompted the markets to once again raise their expectations about monetary firming, which brought the dollar close to US$0.83 (C$1.205/US$). Since then, the loonie has lost momentum. The economic data had to remain solid to maintain the lofty expectations regarding rate increases and the Bank of Canada (BoC) had to keep sending signals in this direction. However, this is not what happened. The latest economic data were mixed, and the BoC worked to lower expectations. From the market s point of view, the Canadian dollar is still on an upward trajectory despite the recent pullback. Moreover, investors continue to position themselves in anticipation of an increase in value, as shown by the high level of net speculative positions. The BoC indicated that its future monetary policy decisions will depend on the upcoming economic data. As a result, the Canadian dollar is now highly sensitive to the Canadian data. In addition, oil prices seem to have had less of an impact on the exchange rate over the last few weeks. The recent rise in crude oil prices to more than US$50 a barrel did not lead to an increase in the value of the Canadian dollar. That being said, it may have limited the currency s depreciation. The fears surrounding U.S. protectionism have gone up recently because of the difficult negotiations to upgrade the North American Free Trade Agreement (NAFTA). The United States threats to leave the free-trade zone pose another problem for the loonie. The addition of customs tariffs on Canadian exports would hurt the Canadian economy. In the short term, even if NAFTA remains in place, businesses could be more reluctant to invest. This could also prompt the BoC to be more cautious. Forecasts: The Canadian dollar s potential for appreciation appears weaker. Nevertheless, it could return to more than US$0.80 (under C$1.25/US$) between now and the end of the year if the Canadian economic data are sufficiently good to prompt the BoC to announce another interest rate increase. Unless there is a shock, such as the United States withdrawing from NAFTA, the loonie is expected to gain a few more cents in. This scenario assumes that monetary tightening will continue because of the inflationary pressures that will become more evident next year. CANADIAN DOLLAR C$/US$ (inverted scale) Canadian exchange rate CANADIAN DOLLAR Momentum Quarterly variation in % CANADIAN DOLLAR Net speculative positions In % OCTOBER 3

4 Euro (EUR) Continued Monitoring of Central Banks Required The euro s spectacular rise continued until early September, when the common currency temporarily rose above US$1.20. Recent weeks were more difficult, as a rebound of the U.S. dollar, especially after the Federal Reserve s (Fed) last meeting, helped to drive the euro down to approximately US$1.17. Moreover, within the context in which the European Central Bank (ECB) clearly indicated its unease with the rise in the value of the euro, it became harder to bet on another increase in the value of this currency. The return of political uncertainty, in particular following the referendum in Catalonia, also negatively impacted the euro recently. The euro continues to rely on a favourable economic situation. During the first six months of, real GDP in the euro zone rose at an annualized rate of 2.4%. This is double the rate that the European Commission estimates will be potential GDP growth. The high level of the leading indicators implies that growth will continue at a steady pace, which should help reduce the overcapacity in manufacturing that has been plaguing the euro zone since the 2008 recession. Furthermore, the unemployment rate is decreasing more and more, and increasingly approaching the non-inflationary unemployment rate. For now, inflation remains, nonetheless, very low, with an annual rate of only 1.5% in September, and a core inflation rate of 1.1%. Until now, low inflation prompted the ECB to maintain a very cautious tone despite the improvement in the economic situation, especially as it wanted to avoid encouraging an even greater increase in the value of the euro. Nonetheless, the ECB will soon have to make a decision on buying bonds, as the current 60B monthly purchasing program will end in December. The most recent rumours imply that this could drop to 30B per month, and remain at this level throughout much of. This kind of decision could essentially close the door on an increase in key interest rates in the euro zone next year. Forecasts: Upcoming announcements by the ECB could lead to significant fluctuations in the value of the euro. Subsequently, developments at the Fed could be determining factors. If the Fed pursues a gradual tightening of its monetary policy, as we expect, the euro should pull back a little more over the course of the next few months. EURO US$/ Euro zone exchange rate EURO Momentum Quarterly variation in % EURO Net speculative positions In % OCTOBER 4

5 British Pound (GBP) The Uncertainty Could Catch Up With the Pound Next Year The British pound has generally remained strong over the last few months, and even rose above US$1.35 for a short while in mid-september, when the Bank of England (BoE) signalled its intention to increase its key rates soon. The pound s strong performance since the beginning of the year is in contrast to the United Kingdom s difficult political situation. Theresa May s election gamble to strengthen her negotiating position with Europe completely failed, and she ended up with a weakened government and a highly contested leadership. The Brexit negotiations seem to have reached a complete impasse. Although it hasn t collapsed, the British economy has slowed down considerably in recent quarters, and there is no sign of a rebound any time soon. However, the BoE believes that the uncertainty surrounding Brexit is also hampering the potential for the British economy to grow and, therefore, anticipates that excess production capacity, already limited as unemployment is at its lowest in more than 40 years, will continue to decrease. Given that inflation reached 3% in September, the BoE is expected to announce at its meeting on November 2 that it will be raising its key rates, which could help the pound in the short BRITISH POUND US$/ British exchange rate term. Nonetheless, the under-performing British economy should weaken the pound in. A political crisis could also occur at any time. Swiss Franc (CHF) The Swiss National Bank Seems to Have Won Its Wager The Swiss franc appreciated against the U.S. dollar, as have other European currencies, up until early September before a part of its gain was wiped out recently. The most interesting development is, however, the extent of the franc s pullback in relation to the euro this year, as the EUR/CHF pair increased from roughly 1.07 francs in early to 1.15 francs. The Swiss National Bank (SNB) seems to have succeeded in discouraging speculators from betting on an appreciation of the franc by implementing negative rates and by intervening heavily in the foreign exchange markets. The SNB will remain vigilant, but it may have to intervene less often now that the franc is no longer very far from the floor price of 1.20 francs/ that it had to abandon in. The gradual rise in inflation is also encouraging, but the latest data on economic growth reveal a quasi-stagnation of the Swiss economy over the past year. Within this context, the SNB should opt to maintain an ultra-accommodating monetary policy for a long while, which could help the franc pull back a little more against the euro in. SWISS FRANC Exchange rate Franc/US$ Franc/ Franc/US$ (left) Franc/ (right) OCTOBER 5

6 Yen (JPY) The Pace of Depreciation Could Quicken At 107.3/US$, the Japanese exchange rate reached its lowest level this year in September, and is now fluctuating between 113/US$ and 114/US$. The recent volatility can essentially be explained by the U.S. dollar fluctuations and by the change in expectations regarding monetary policies. Despite the improvement in the Japanese economic data over the last few quarters, the Bank of Japan (BoJ) still seems extremely reluctant to take its foot off the gas. Inflation has increased, but, at 0.7%, it clearly remains below the target of 2%. Furthermore, the BoJ has indicated that it will continue expanding the monetary base until inflation exceeds 2% and stays above that target in a stable manner. The expected gap between the U.S. and Japanese monetary policies prompts us to remain pessimistic with respect to the yen. The exchange rate is expected to reach roughly 115/US$ near the end of the year and continue to rise to approximately 120/US$ in. YEN /US$ (inverted scale) Japanese exchange rate Australian Dollar (AUD) No Monetary Tightening Expected Anytime Soon Just like other currencies, the Australian dollar has profited from the U.S. dollar s weakness right up until September. A cyclical peak was reached at a little more than US$0.81. The Australian currency also profited from still high terms of trade, the good performance of the Chinese economy, and the encouraging indicators for the Australian economy, especially with respect to employment. The renewed strength of the greenback, and signs that the Reserve Bank of Australia (RBA) will extend the status quo have, nonetheless, put an end to the surge of the Australian dollar, which is now fluctuating around US$0.78. The RBA seems reluctant to follow the path of monetary tightening, which more and more central banks are doing. The RBA believes that the Australian economy will have to improve before it goes ahead with any rate increases. The strong employment numbers recorded in will help sustain consumer spending, however, at the same time, the weak growth in real salaries and high levels of household debt are a significant hindrance. Furthermore, inflation is sitting below the target range of 2% to 3%, and the RBA indicates that another rise in the currency s value would negatively impact its inflation AUSTRALIAN DOLLAR US$/A$ Australian exchange rate forecasts. With no signals regarding possible monetary tightening, and bearing in mind that the U.S. dollar could still appreciate, we remain pessimistic about the Australian dollar in the short term. OCTOBER 6

7 Emerging Currencies Difficult NAFTA Negotiations Are Hurting the Peso CHINESE YUAN (CNY) Significant fluctuations in the U.S. dollar continue to dictate the trajectory of the Chinese currency. The exchange rate dropped below 6.45 yuan/us$ in early September, before the U.S. currency rebounded. The Chinese exchange rate is now fluctuating around 6.65 yuan/us$ and is expected to reach 6.70 yuan/us$ by the end of the year, seeing as the U.S. dollar is expected to record more gains. Nevertheless, it seems that China is increasingly open to the idea of allowing the currency to float more freely. In early October, the governor of the Chinese central bank argued in favour of reducing the controls on capital. This kind of easing could make the currency more attractive in the long term. CHINESE YUAN Yuan/US$ Chinese exchange rate MEXICAN PESO (MXN) The peso significantly declined in value at the end of September to return around 19 pesos, while the negotiations surrounding the North American Free Trade Agreement (NAFTA) took a worrisome turn, bringing back fears that the agreement would be completely abandoned. The Bank of Mexico (BoM) is in a difficult position as the Mexican economy, despite its resilience, is facing several major threats and requires support. Nonetheless, the BoM is forced to keep interest rates very high in respond to an inflation rate exceeding 6% and to the risk of another drop in the value of the peso. The NAFTA negotiations are expected to remain a determining factor for the peso in the coming months. MEXICAN PESO Peso/US$ BRAZILIAN REAL (BRL) The Brazilian exchange rate has been fluctuating between 3.10 reals/us$ and 3.20 reals/us$ since July. The political uncertainty remains significant, as suspicions of corruption hang over President Michel Temer. However, the effect on the currency is less than it was during similar situations, in particular during the dismissal of former President Dilma Rousseff. The economy improved in, marking the end of a hard recession. The rate of inflation also declined significantly, which allowed the central bank to relax its monetary policy. The drop in interest rates is improving the outlook for economic growth, which is underpinning the currency. We do not foresee any major changes in exchange rates in the coming months unless the economy slumps or the political uncertainty worsens. The volatility in exchange rates should largely be caused by fluctuations in the U.S. dollar. Mexican exchange rate BRAZILIAN REAL Real/US$ Brazilian exchange rate OCTOBER 7

8 TABLE 1 Currency market: Yields VARIATION (%) SPOT PRICE LAST 52 WEEKS Oct 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 , , , ,113 Europe Denmark krona Euro zone (EUR/USD) Norway kroner Russia ruble Sweden krona Switzerland swiss franc United Kingdom (GBP/USD) COUNTRY CURRENCY* * 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 Q1 Q2 Q3 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 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 = 100). Sources: Datastream, Federal Reserve Board and Desjardins, Economic Studies OCTOBER 8

January s currency movements will probably not be typical of the rest of the year

JANUARY 3, 217 FX FORECASTS January s currency movements will probably not be typical of the rest of the year HIGHLIGHTS Despite a recent downturn, the U.S. currency is still holding onto some gains won