FX Forecast December 2023 – US dollar giving up the steam

For information purposes only

USDCAD Q4 23

Median 1.31
High 1.37
Low 1.24

Forward 1.35

After two years of dominance of the US dollar over all the other major currencies, the recent remarks by the US Central Bank officials led to the markets starting to expect interest rates cut soon which led to the US dollar losing steam.

After the most aggressive rate hike regime in more than 40 years to combat sticky inflation which pushed the policy interest rate to 5.5 in the US and 5% in Canada, the US dollar became the high-yielding safe haven currency beating all the other major currencies. The Canadian dollar also enjoyed the higher oil prices and high yields and to some extent managed to keep up with USD.

European currencies were slow to increase rates and also faced a more severe economic situation including the impact of higher energy prices which led to unprecedented depreciation of the Euro and British Pound against the USD. Japanese Yen was hit hard since they were reluctant to touch their policy rate as always.

The plethora of economic data kept pilling on top of each other that inflation remains sticky. US central bank increased rates one last time in July and kept the door open for further hikes. In November, however, the Fed Chari, Jerome Powell, and other officials clearly noted that they are done with rate hikes and even willing to cut the rates sooner.

The move came after the signs of weaker economic data started to appear in the US economy and markets started to speculate a hard recession coming in 2024. The dovishness from the officials led to market euphoria with stocks and bonds skyrocketing and the US dollar showing signs of weakens.

In theory, if the US offers lower interest rates and the risk of global recession is not high, investors will seek out yields in other countries especially Emerging Markets like China, Brazil, Mexico, etc.

The swap curve in the US is pricing in 5 or 6 rate cuts which is 1.25% for 2024 with the first one coming before June. The markets curve is more aggressive than the dot plot which is the expectation of the US central bank policy committee.

Having that in mind, the US dollar may have oversold and at least will hold the ground for the rest of December.

Canadian dollar
The Canadian dollar, on the other hand, does not seem to have the support needed going forward. The energy prices have come off from their year highs, with WTI Crude trading at US$73 a barrel which does not provide the conventional support for CAD. The economic indicators are worse than the US with record-high immigration putting pressure on the Canadian economy.

The Bank of Canada is more likely to lower rates first because of their fear of the amount of household debt people are carrying and the number of mortgages coming up for renewal soon. At the same time, any lower rates will send the house prices to the moon again so officials are walking on thin ice.

The overall outcome for Canada cannot be imagined to be positive in 2024 and the currency could eventually see further depreciation.