MARKET TONE
The US dollar (USD) looks to have stalled following its Q2 rally, and recent price action has leaned toward a slight bearish drift in the first few weeks of July. Fundamentals have shifted as markets have tempered their expectations for Federal Reserve (Fed) tightening while pricing in renewed hawkishness among most of the Fed’s peer central banks. Interest rate differentials are softening and eroding a fundamental pillar of USD support however sentiment appears to be providing an important near-term offset as market participants assess the resurgence in geopolitical tensions and the re-escalation of the US/Iran conflict.
We maintain a broadly bearish USD outlook primarily driven by expectations for Fed easing, with 50bps of cuts forecast in the first half of 2027. The arrival of Fed Chair Warsh has produced an ambitious and potentially transformative effort to re-evaluate the Fed’s policy framework, with the creation of five independent task forces to review key aspects of how the Fed conducts its monetary policy.
The task forces are set to review the Fed’s communication and balance sheet policies and will also evaluate data sources as well as productivity in the current environment of transformative AI innovation. Finally, and most importantly, the review will also reassess the central bank’s inflation framework. At a minimum, we see this review effort as a meaningful reason to fade any hawkish pricing that is currently reflected in short-term interest rate markets, as policymakers take time to assess the work of the task forces.
A greater bearish risk lies with the potential for a definitively dovish turn if the Fed reframes its inflation mandate in favour of narrower measures that have been previously highlighted by the newly arrived Fed Chair. A focus on measures like the trimmed-mean and median PCE has been floated as a consideration by Chair Warsh.
We see material downside risk for the USD, given current pricing, and note the potential for a clear divergence in policy rate paths as major central banks like the ECB, BoE, BoJ, and BoC guide for tighter policy.
Cyclical risks are material as we continue to highlight the US economy’s ‘twin deficits’ (trade, fiscal). And we also see potential for longer-term pressures resulting from global rebalancing flows as investors seek to diversify their overallocations to US (and USD) markets following an extended period of USD (and US market) outperformance.
Outside of the US, central banks remain firmly constrained by their single mandates and are thus much more sensitive to the energy price shock as they seek to contain the risk of second round inflation effects. A wide range of policymakers across developed economy central banks have clearly tied their policy outlook to both the severity and duration of the crisis, allowing for a dynamic market response to geopolitical developments.
Policy divergence remains a core pillar of our fundamental outlook, and we expect this to continue through the second half of 2026 and into 2027 as the Fed moves to cut and other central banks move toward tightening.
The Canadian dollar (CAD) has entered Q3 with an attempt at a modest recovery of its 2% Q2 decline vs. the USD. The outlook for relative central bank policy remains a dominant driver for the CAD, as yield spreads reflect the market’s assessment of shifting risks to both inflation and growth—the latter conditioned by trade policy uncertainty following the deterioration in the state of negotiations between the US and Canada.
We still maintain a medium-term bullish CAD view, largely conditioned on an outlook for central bank policy that forecasts a material narrowing in US-Canada policy rate differentials. The forecasted Fed easing is paired with 75bps of tightening from the Bank of Canada, leaving the BoC at 3% by the end of our forecast horizon.
Sentiment and positioning continue to lean bearish CAD and we continue to see this as a major vulnerability. The medium-term chart continues to be one of retracement, as the CAD recovers from its late 2024/early 2025 decline. Our fair value CAD estimate has converged with spot, suggesting a return back to fundamentally driven movement in the currency.
We recently adjusted our USDCAD forecast while maintaining the declining profile. We have a Q4 2026 target at 1.37 and a Q4 2027 target at 1.33.
The EUR’s performance has remained dull, extending the flat trading range that has prevailed since June 2025. Defensive price action observed through much of Q2 has given way to stabilization, with fundamental support offered by improving interest rate differentials.
The ECB’s hawkish tone has been matched with action, as the central bank delivered the first hike among the G4 (Fed, ECB, BoE, BoJ) since the start of the US/Iran conflict. This was followed by the BoJ, and is set to be followed by additional ECB tightening in September. The BoE’s policy guidance has been much more dynamic, but appears to be once again pricing in at least one—and potentially a second—hike before year-end.
The GBP’s performance has reflected a considerable amount of resilience through its latest political transition with the departure of former PM Starmer and the newly arrived Burnham. The choice of former Defence Secretary Healey for Chancellor of the Exchequer has been relatively well accepted by markets, and overall communication has emphasized a respect for ex-Chancellor Reeves’ self-imposed fiscal rules.
The yen’s (JPY) performance remains worrisome, as the currency extends its slide to fresh multi-decade lows reaching levels last seen in 1986. Japanese officials have shown considerable reluctance in relying on further intervention following their intrusions earlier this year, likely due to concerns about moving from temporary or episodic support to something resembling persistent management.
The Australian dollar’s (AUD) performance has been varied, but has shown signs of stabilization following a pullback from its multi-year high reached in early May. Both the RBA and RBNZ are providing hawkish guidance—the latter offering it somewhat belatedly in a manner that has generated an importance recovery for the New Zealand dollar (NZD). In Latam, the MXN’s performance appears to have stalled following an impressive recovery of its 2024/2025 decline. The PEN’s performance has also been erratic through much of 2026, marking a phase of choppy consolidation following an impressive near-25% rally from its 2021 low.
Eric Theoret, Canada 416.863.5934
FX FORECASTS
CAD FX FORECASTS
NORTH AMERICA
MAJOR CURRENCIES
MAJOR CURRENCIES (continued...)
LATIN AMERICA
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