- The U.S. dollar’s trajectory will likely be dominated by the pace of future rate hikes now that the Fed has begun a tightening cycle. We think the Fed might hike rates three or four times in 2016, more than the two priced into markets. Such a pace would be U.S. dollar bullish and underpins our current bias.
- Stubbornly low inflation for the euro area should give the European Central Bank (ECB) the green light to maintain stimulus measures despite pockets of economic strength that emerged in Q2 2015. In particular, we think the ECB’s reduction of the deposit rate further into negative territory should ultimately weaken the euro versus its peers through 2016. We maintain our tactical-bearish forecast for the currency.
- The Canadian dollar reached new cycle lows as commodity prices weakened further into the end of the year. Any rally back to or beyond purchasing power parity (about US$0.83) is dependent on a sustainable recovery in oil prices or a reacceleration in the manufacturing sector. However, neither seems likely in the near term. The Bank of Canada’s updated framework for unconventional policy illustrated its dovish bias in the face of challenging economic conditions. We expect this bias to keep pressure on the loonie.
- Political risks could blunt the tailwind to sterling that a stronger economy seems set to provide. Recent economic activity in the U.K. has been robust and suggests to us that the Bank of England may be in a position to hike rates ahead of the current “early 2017” hike that is priced into financial markets. However, political headwinds, driven by the approaching referendum on euro area membership, coupled with stubbornly benign inflation in the U.K., might delay the timing of the first rate hike and somewhat negatively impact the pound’s performance through 2016.
- Clues remain elusive as to whether the BoJ will expand its quantitative easing program in 2016. We maintain our bearish bias for the currency as the BoJ remains committed to using monetary policy to push inflation higher and lift economic growth. We believe yen weakness is likely, given the Fed is now in a “hiking” cycle, and the yen is likely to remain a long-term “funding” currency of choice for the carry trade through 2016.
Recovery for Canadian dollar dependent on oil
Source - RBC Wealth Management, RBC Capital Markets, Bloomberg
Recent decline in Canadian dollar mirrors the fall in crude oil prices throughout 2015.