Foreign Exchange Outlook

MARKET TONE

The US dollar (USD) is heading into the end of the year on a firm note, reflecting some easing in trade tensions on the one hand and resilient growth trends that have tempered Federal Reserve (Fed) rate cut expectations on the other. The lengthy federal government shutdown has deprived markets of key information on the state of the US economy, helping the USD strengthen through October on the basis that no news is good news.

We are marking to market some of our near-term forecasts now as the year end approaches and moderating our expectations for USD weakness over the coming quarters in response to recent developments. But our base case remains that the USD will weaken over the coming year and into 2027—for several reasons. While growth trends appear to be holding up, prospects remain uncertain and some trends in key data reports (such as the ISM series) remain sluggish. Treasury Secretary Bessent has gone as far as to suggest that some sectors of the US economy are in recession. Focus on credit risks, soft housing market trends and uneven consumer spending may add to concerns about the outlook. Lofty equity market valuations are also an area of concern as any significant setback in risk assets could add to economic headwinds via the confidence and consumption channels.

We are confident that the US policy rate will experience a sustained decline over the course of the coming year despite the contradictory signals on the US economy right now. Scotia’s forecasts anticipate 100bps of easing over the coming year and the Fed holding its key target rate at 3.00% for the foreseeable future thereafter. At the time of writing, markets are pricing in around 16bps of easing risk by the end of this year and a little more than 80bps of easing in total through the end of 2026.

Easier Fed policy settings will contrast with stable or slightly tighter monetary policy in many other major currency jurisdictions in the coming year, compressing the USD’s yield advantage. We continue to forecast some slowing in US growth and remain cognizant of the significant structural challenges facing the USD, primarily a reflection of the wide fiscal and current account deficits that are expected to develop in the US over the next few years. Lower US yields will cheapen hedging costs which may lead to increased mitigation of USD exposure by foreign investors, adding to bearish pressure on the USD.

Although it’s very early in the process, there is little evidence to suggest that President Trump’s tariff policies are having much impact on the US trade imbalance or, more especially, reviving US manufacturing at home. A weaker USD remains a potential lever to support the president’s trade objectives.

We should note that there are potential USD positives that should not be overlooked. Primarily, US economic growth remains resilient. The St Louis and Atlanta Fed’s GDP tracking models suggest that Q3 growth may have picked up a little from the 3.8% (SAAR) rate seen in Q2. Uncertainty about the US economic situation, exacerbated to some extent by the lack of US economic data, has resulted in an unusually large and public split among US monetary policy makers about the outlook for rates. Uncertainty here could persist, sustaining support for the USD in the short run. Seasonal considerations are also USD-supportive in Q4—until closer to year-end when late-year gains in the USD tend to correct somewhat.

The Canadian dollar (CAD) has been pulled lower by a combination of a renewed widening in US/Canada short-term rate differentials, ongoing trade uncertainty and a spike in market volatility through early November. The Bank of Canada’s (BoC) October rate cut is, we believe, the last in the cycle. Monetary policy is at the lower end of the neutral range and policymakers have made it clear that rate cuts can only do so much to help the economy adjust to structural (trade) challenges.

Loose monetary policy and significant fiscal stimulus provided by the Federal budget will help backstop Canadian growth. US/Canada interest rate differentials should narrow substantially through 2026 as the Fed eases further and, we expect, the BoC tightens policy late in the year. This should lift the CAD. Our forecasts anticipate the policy rate gap narrowing significantly through 2027.  We have adjusted our end-2026 USDCAD forecast to 1.33 and introduce a 1.30 forecast for end-2027. Our macro-economic forecasts (particularly regarding monetary policy) support the outlook for some strengthening in the CAD over the medium-to-longer term. We have to concede that trade policy risks are a clear and present danger for the CAD and Mexican peso (MXN) in the coming year, however.

The euro (EUR) has stabilized after suffering a mid-year setback around political uncertainty in France and mediocre economic data. The asset diversification into Eurozone equity markets that helped lift the EUR in H1 appears to have faded in H2. We expect a resumption of EUR gains in 2026, reflecting steady, if moderate, growth and stable European Central Bank (ECB) monetary policy. Sterling (GBP) remains relatively “cheap” from a longer run point of view, we feel, and although we expect some additional easing from the Bank of England (BoE) in 2026, some easing is already priced in, and the key UK policy should retain a small premium to the Fed funds target rate. The GBP should still be able to advance against a broadly weaker USD. The Bank of Japan (BoJ) is the only major central bank in our outlook that is poised to tighten monetary policy over the coming year. The yen (JPY) remains very soft, and US Treasury officials have pointedly encouraged the Japanese government to allow the BoJ “policy space” to adjust rate settings. Japanese officials have recently ratcheted up verbal intervention in support of their currency. Our JPY forecast was wide of the mark for this year, but we still anticipate moderate gains for the JPY in 2026.

Easing trade concerns have helped Latam FX hold steady or firm modestly since mid-year while attractive carry has helped the Colombian peso (COP) outperform. The Chilean peso (CLP) is a clear underperformer, however, amid elevated copper volatility and investor caution ahead of the mid-November general election. Our forecasts anticipate generally steady to marginally softer trends for the regional currencies over the coming year but concerns about negative tail risks may remain close to the surface amid security and economic challenges. 

Shaun Osborne, Canada 416.945.4538

FX FORECASTS

CAD FX FORECASTS

FEDERAL RESERVE AND BANK OF CANADA MONETARY POLICY OUTLOOK

FEDERAL RESERVE—FURTHER EASING AHEAD 

We forecast with modest confidence a further one percentage point of Fed funds cuts down to 3% by 2026Q2 followed by a prolonged hold. This is expected to unfold in a series of quarter point meetings.

On the dovish side of the arguments are concerns about future growth and how the labour market evolves.

GDP growth matters to correlated growth in jobs and as input into estimating capacity pressures that matter to inflation forecasting. You’ve heard slowing growth narratives before, but we have somewhat greater confidence in this narrative now. Tight immigration policy could knock 0.5–1.0% off GDP growth. High uncertainty across broad areas of policy is dampening confidence. Tariffs are driving efforts to slash costs. Broader supply chain pressures are likely to pass through to higher prices and dampen purchasing power. Outside of AI-related spending the investment picture is soft and AI enthusiasm is looking over stretched.

The job market is slowing and history suggests it can rapidly turn south. Continuing claims point to rising unemployment. Alternatives to suspended nonfarm payrolls are looking weak. Consumers have a strong track record at predicting unemployment and the signal is bleak (chart 1). A fuller take on the job market is here. 

On the hawkish side is that upside inflation risk is elevated but we think the FOMC will once again be more spooked by what happens to the job market. The US economy is in excess demand with a positive output gap that could turn to slack but with long lagging effects while supply chain cost pressures are likely to rise. Tariffs are only a subset of such pressures but it’s unclear that likely pass through will be transitory. It’s too soon to say productivity growth may temper some of the inflation risk and the US could be in an investment bubble.

An added uncertainty is FOMC communications. Some members have a cavalier attitude toward surprising markets. Instead of crafting policy by empirically assessing whether risks are more tilted toward higher unemployment or higher inflation, Chair Powell’s recent remarks indicate individual differences over what matters more. 

BANK OF CANADA—NEXT MOVE UP?

The BoC is forecast to be on a long pause at an overnight rate of 2.25% after cutting by 50bps in what we had forecast as a fine-tuning exercise rather than the start of a major downleg.

A clear hold signal was offered in the October statement that said if their forecasts broadly hold, then “Governing Council sees the current policy rate at about the right level.” They slightly raised their inflation forecast to just above 2% sustainably through 2026–27 to support the signal they are done cutting.

There are upside and downside risks to their projections. Some of them include plans versus reality for fiscal policy (chart 2), as well as high uncertainty around trade negotiations and the pending Supreme Court IEEPA decision.

Key is that while there is a modest amount of disinflationary slack in the economy, the BoC has a better understanding of the supply side this time and expects rising cost pressures to offset slack effects on inflation. Holding higher inventories, wage pressures, terrible worker productivity, and the costs of reworking supply chains to find new markets are examples of such cost pressures. Consumers are likely to pay for some of this through complicated incidence effects.

What’s happened since they published their forecast? GDP is weak but tracking close to their Q3 forecast. Job growth is somewhat curiously on a tear with 127,000 jobs created in the past two months. The federal Budget struck a balance between adding modest stimulus but without going overboard. Trade negotiations are stalled, but CAD depreciation is acting as a shock absorber.

While very tentative, we continue to forecast that the next policy rate move is eventually up with hikes by late 2026. That would restore the rate to the middle or upper half of the neutral rate range.

Derek Holt, Canada 416.863.7707

NORTH AMERICA

MAJOR CURRENCIES

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LATIN AMERICA

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