The US Dollar-to-Canadian Dollar (USD/CAD) dipped to 34-month lows near 1.2500 in February.
The selling of US dollars to buy commodity currencies and emerging-market currencies has been a popular trade over the past few months, especially with Federal Reserve interest rates close to zero.
Currency analysts at CIBC consider whether there is scope for this trend to continue with the bank naturally focusing on the Canadian dollar.
Although the Canadian dollar can secure further short-term gains, especially if oil prices remain strong, the bank does not consider that the trend can continue for long given trends in the US economy.
CIBC now expects a much stronger US economy and also that the Federal Reserve will tighten policy earlier than expected by markets.
“We now expect the Fed to hike rates twice in H2 2022 while the BoC should follow with a hike of its own in Q4 2022.”
Given that markets are not expecting a rate hike until late 2022 or early 2023, there is scope for a significant re-pricing that will underpin the US dollar.
CIBC notes that markets are currently expecting the Bank of Canada (BoC) to increase interest rates before the Federal Reserve with the first increase between June and September 2022.
Looking back at previous cycles, the BoC raised rates ahead of the US on two occasions, but not when the US was experiencing strong growth.
Given the expectations of a very strong US recovery, CIBC does not expect the BoC to tighten first.
CIBC notes expectations that the Fed’s net average inflation target will delay any US tightening, but doubts this will prove realistic given the relative dynamics.
“That’s a hard message to hold onto over the long-term if US growth is expected to outperform and there’s still an ample degree of slack in the Canadian economy.”
CIBC also expects that the BoC will be sensitive to exchange rates and will, therefore, delay tightening due to fears that the currency will strengthen too far.
Traders still short US dollars:
CIBC also noted that there is still a substantial short US dollar position in global currency markets.
Wider pressure to buy-back the dollar would also undermine potential support for the Canadian currency, especially if there is a further shift in yields and expectations of rapid Fed tightening.
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