FX forecast February 2024 - US dollar remains strong so as the US economy

USDCAD Q1 2024

Median: 1.35
High: 1.37
Low: 1.32
Forward: 1.35

The US dollar and equity market

The first two months of 2024 have further affirmed that the US will not enter the anticipated economic recession, with additional economic data such as unemployment and consumer spending demonstrating the resilience of the economy. However, the markets have been calling for six rate cuts in 2024, amounting to 1.5% from the current 5.5%. US officials have reiterated their expectation of only three rate cuts in 2024, citing the Consumer Price Index (CPI) and Personal Consumption Expenditure (PCE), which indicate that inflation is not cooling down as quickly as anticipated by the US Federal Reserve. Additionally, central banks are currently monitoring each other, exercising caution regarding which one will lower rates first.

US households are still relying on the excess savings accumulated during the COVID era, and the robust stock markets, fueled by the Artificial Intelligence boom, are also contributing to household wealth. The low unemployment level of 2.7% is not posing a recession risk nor lowering price risks. For the past two years, the US dollar has dominated the foreign exchange market, offering an attractive carry for all FX traders at a 5.5% interest rate.

The belief that rate cuts in the US will not exceed three in 2024, coupled with the lower risk of recession, has propelled the US dollar higher, with the DXY index rising to 104 in February from its lows of 101 in early January. The strength of the US dollar is expected to persist throughout 2024.

Canadian Dollar:
The Canadian economy and stock market continue to underperform compared to its southern neighbor. While the US recorded 3.3% economic growth in Q4, Canada only achieved 0.3%. Various factors such as high immigration, a housing crisis, sticky inflation, and lower household incomes have contributed to reduced disposable income for Canadian households.

The energy prices have not been particularly helpful either. Although West Texas Intermediate (WTI) oil prices increased in 2024, reaching around $77 a barrel in February, they remained much lower than the $90 high of 2023. Geopolitical tensions and conflicts in the region have kept oil prices relatively high, but countries like Russia and Saudi Arabia have increased oil production to meet their financial needs.

Canada also cannot sustain high-interest rates much longer. The latest CPI figures indicate that Canada's inflation stands at 3.1%, which is higher than expected and not in line with the Bank of Canada’s projections. A significant factor contributing to the inflation rate is the cost of rent and shelter, which reflects mortgage servicing costs. Excluding the shelter component, inflation stands at 1.5%, which falls within the Bank of Canada's target range. However, the Bank of Canada's actions are contributing to inflation.

While this is the case, the Bank of Canada cannot afford to lower interest rates as it may lead to a surge in housing prices and subsequent inflation. Moreover, cutting rates faster than the US and other major central banks has further weakened the Canadian dollar, contributing to medium-term inflation.

Overall, the Bank of Canada is awaiting signals from the US Federal Reserve regarding rate cuts, after which they will initiate their hawkish cycle accordingly. In the meantime, the Canadian dollar is expected to maintain its position against the USD but may be more susceptible to underperformance and weakening.