MARKET TONE

Our bullish call on the US dollar (USD) broadly has proven correct, with gains accelerating through April to push the market weighted DXY index up more than 4% from the consolidation range that had prevailed through March. USD appreciation has come primarily at the expense of the yen (JPY), Swiss franc (CHF), euro (EUR) and pound (GBP) among the majors, with the JPY in particular weakening sharply to reach a 20-year low after the Bank of Japan (BoJ) policy decision last month. We are adjusting some of our near-term forecasts to reflect the persistent USD strength but we do think the USD is quite fully priced at this point and we are reluctant to factor in a still higher USD in our thinking in the longer term. However, we recognize that the USD could “overshoot” if elevated risk aversion persists.

Yields and spreads (over its major currency peers) continue to provide essential support for the USD and make it an expensive short against currencies with significantly lower yield regimes. Geo-political risks and equity market volatility add to the USD’s underpinning and seem likely to remain a factor in the weeks ahead. There is no early end in sight to the Ukraine conflict, markets are having to adjust to higher rates and seasonal trends for stocks may turn more challenging over the next few weeks (“sell in May”). While there are obvious, longer-term structural negatives hanging over the USD from a fundamental point of view (large current account and budget deficits, for example), these factors are not relevant at present. Rather, we think the biggest risk for the USD comes from messaging from the Fed which suggested at the early May FOMC meeting that the pace of rate hikes may slow after July as policy settings get closer to “neutral”. Markets are already discounting the Fed funds target rate getting to 3% in early 2023 so there is little room—at this point—for additional rate support to be priced in. Any sign of economic weakness, which could suggest the Fed rate cycle peaks below where markets expect now (or even opens the door to rate cuts in late-2023), will be negative for the USD.

Both the Canadian dollar (CAD) and Mexican peso (MXN) have held up relatively better against the boisterous USD over the past two months. In both countries, central banks have been active in policy tightening and we continue to look for the Bank of Canada (BoC) to boost interest rates significantly amid above target inflation and resilient growth. The CAD has surged on the crosses, pressing the likes of the EUR, GBP and JPY to multi-year lows. It has, however, found making progress against the USD harder to sustain despite Q1 GDP shaping up more strongly than the US, where the economy contracted (if only for temporary reasons). Equity market volatility remains a drag on the CAD’s performance. In Mexico, the central bank is expected to tighten further but policy makers will be attentive to price developments and the course of the economic recovery. Market uncertainties (geo-political, risk appetite) may mean USDMXN remains supported above the 20 zone.

Among the majors, the plunge in the JPY over the past month is the most eye-catching development. After a protracted period of range trading below the 115 zone, the USD’s appreciation through March accelerated in April after the BoJ reiterated (and strengthened) its yield curve control policy and the view, expressed by Governor Kuroda, that the weak JPY was a net benefit for the Japanese economy. Yield differentials are a clear negative for the JPY but the recent weakening in the country’s trade performance and negative terms of trade developments are bearish factors as well. JPY weakness spilled over into the Asian regional currencies, where competitive considerations do shape currency movements. The Chinese yuan (CNY) and Korean won (KRW) fell sharply over the past month, with slowing activity in China amid the country’s aggressive lockdown measures also weighing on the CNY. Downside risks for the JPY remain, particularly if commodity prices pick up renewed momentum but we think the JPY is starting to look oversold from a medium-term point of view after a relentless, near 15% rise in the USD since early March.

In Europe, a decisive win for French President Macron in April’s election was not the catalyst for a EUR rally that it was in 2017. Rather, investors remain focused on the war in Ukraine, European energy security and the risks of negative economic consequences that could stem from an escalation in the conflict. Nevertheless, European Central Bank (ECB) policy makers appear intent on raising interest rates to combat inflation. Modest rate rises are possible over the balance of the year but we err on the side of the ECB tightening a little less than market expectations currently and feel that policy tightening that will barely get short-term rates above zero will still leave the EUR at a significant rate disadvantage versus most of its peers. A quick end to the war in Ukraine or a negative development for the USD is needed to lift the EUR materially in the next few months, we feel. Bank of England (BoE) policy makers are also likely to extend the moderate tightening in monetary policy that started late last year a little further. But the UK cost of living crisis represents a significant restraint on consumer activity. The BoE rate cycle is likely to proceed with very cautiously and peak significantly below current market expectations, representing a downside risk for the GBP.

Pacific Alliance currencies fell sharply in April as domestic inflationary pressures intensified but losses have stabilized more recently as policy makers have reaffirmed their commitment to battling prices with larger than expected increases in benchmark interest rates (Chile, Colombia).

Shaun Osborne, Canada 416.945.4538

FX FORECASTS


CAD FX FORECASTS


FEDERAL RESERVE AND BANK OF CANADA MONETARY POLICY OUTLOOK

FEDERAL RESERVE—WHAT’S BETTER THAN 50-50

Scotiabank Economics forecasts three half-point hikes over the June, July and September meetings followed by quarter point hikes in November and December. Our present forecast anticipates ending 2022 at a policy rate of 3% and then maintaining this rate throughout 2023. The result would be to slightly overshoot estimates of the nominal neutral policy rate by approximately half a percentage point.

Tightened financial conditions are to be expected as a key ingredient to transmitting tighter monetary policy throughout the economy and the financial system and they reflect priced expectations for policy action. To date those broad financial conditions have not changed to the point to which we would judge there to be risk of inviting greater caution by the Federal Reserve.

BANK OF CANADA—THE BEST SHOT AT NEUTRAL 

Scotiabank Economics forecasts three half-point hikes over the June, July and September meetings followed by quarter point hikes in October and December. This would end the year at an overnight lending rate of 3%. We think that will be the end of rate hikes for this cycle, but that view will be conditioned upon further information on inflation, activity readings and external developments. There is probably greater risk of overshooting than undershooting this forecast given the magnitude of the inflation challenge.

In fact, if the Bank of Canada cannot get to a neutral policy rate setting and beyond then perhaps no one in its peer group of global central banks can. The BoC has the strongest case for already being at neutral of any peer group central bank. It has among the purest price stability mandates with inflation running at more than triple its target alongside 450k more jobs than before the pandemic. The economy is in a state of excess demand and getting a large positive lift from higher commodity prices that began before the war in Ukraine. Further, while other countries are seeing fiscal stimulus retrench, Canadian fiscal policy keeps priming the pump. Challenges like high debt levels and housing affordability are common across much of the world, yet the Bank of Canada faces among the most forgiving circumstances of any major central bank. 

Derek Holt, Canada 416.863.7707

NORTH AMERICA


MAJOR CURRENCIES

LATIN AMERICA


ASIA



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.