FX Forecast for May 2024: Bank of Canada Ready to Cut

FX Forecast for May 2024: Bank of Canada Ready to Cut
USDCAD Q3 2024

- Median: 1.36
- High: 1.41
- Low: 1.31
- Forward: 1.36

The US dollar index (DXY) showed less strength throughout May as certain economic data, including the PMI, indicated less optimism regarding the manufacturing sector. The latest JOLTS job report revealed significantly fewer job openings compared to even the lowest forecasts. Nonfarm payrolls, wage inflation, and unemployment data for May will provide more clarity on the direction of the USD.

The array of positive economic data in the past two months, coupled with stock market indices reaching all-time highs, has led markets to believe that the US economy is so strong that the chances of rate cuts in 2024 are minimal.

Tech stocks have continued to boost equity markets, with NVIDIA posting yet another outstanding earnings report. However, the reality of the US equity markets is that the winners are taking it all. Though the S&P 500 index is reaching new levels, it is mainly driven by the biggest companies getting bigger.

The S&P 500 is a market capitalization-weighted index, meaning the larger a company, the higher its weight in the index. This is why the top seven giant companies make up more than 20% of the overall US stock market. Meanwhile, the equal-weighted index, which gives equal weight to all 500 stocks in the S&P 500, is at its lowest level since 2009. This is a clear sign that not all companies are doing well, reflecting hidden weaknesses in the US economy.

Almost all central banks around the world, including those in Europe, Asia, Canada, and emerging markets, are expected to lower rates in 2024. The US is considered an exceptional player in this regard.

Perhaps this time is different, and the US will perform exceptionally well compared to the rest of the world. However, if history has taught us anything, it is that economic downturns hit unexpectedly, as seen with COVID-19 and the 2008 financial crisis. Even so, the scenario of a substantially weakening US dollar is far-fetched.

The thesis remains that the US Central Bank will be the last to lower rates, and the US dollar will remain strong in 2024 unless a systematic risk materializes.

**Canadian Dollar**

The Canadian economy is not performing as well as the US and is expected to be the first to lower interest rates. Policy interest rates are at 5% for Canada versus 5.5% for its southern neighbor. The latest GDP report for Canada showed 1.7% growth year-over-year, compared to the 2.4% forecast by the Bank of Canada. High household debt, low growth, and an increased unemployment rate all signal that the Bank of Canada is ready to cut interest rates.

The housing problem in Canada continues to be a major hurdle, with new construction not keeping up with demand. Canada needs around 400,000 new homes every year to accommodate the influx of immigrants, while only around 240,000 are currently being built, with new permits showing a downward trend.

Core inflation has also improved more in Canada than in the US, adding to the thesis that the Bank of Canada will cut its policy rate faster than the US. The US futures curve shows only a 0.4% expected rate cut by the end of the year, while Canada is showing around 0.75%, or around three cuts, baked into the curves.

On the other hand, oil prices have fallen from highs of over $85 a barrel, with WTI now hovering around $73, which is not ideal for Canada. The Canadian dollar is trading at around 1.37 against the USD but could depreciate to around 1.40 as early as the end of June.