The outlook for the US dollar is uncertain as it could be supported by the economy’s resilience and continued rate hikes by the Federal Reserve. However, the Fed may still undershoot the market’s hiking expectations, leading to a potential weakening of the USD by mid-year as attention turns to other advanced economies that are raising interest rates. The Canadian dollar may experience near-term softness due to the policy divergence between the Fed and the Bank of Canada, but a broad weakening trend in the USD by mid-year could give CAD a lift.
The euro is expected to maintain a constructive medium-run outlook due to further European Central Bank activism and a building recovery story. While signs of political instability and a correction in implied rates may cause a correction in recent gains for the British pound, an appreciation in the medium term is expected. Policy normalization and higher Japanese government bond yields may lead to a bias for USD/JPY to test towards 120 into year-end.
Commodity-linked currencies like the Australian and New Zealand dollars have given up ground to a firmer USD over recent weeks, and some further consolidation may be expected before lows are established. Central banks in Latin America have been dialing up cautious/hawkish stances. Initial market confidence and upbeat sentiment on the outlook for the Chinese economy upon its emergence from zero-COVID have been tempered, while a rebound in the USD has lifted USD/CNH back toward 6.90. Some near-term consolidation is anticipated for FX Asia.
Weaker Canadian Dollar to Impact Interest Rates
A weaker Canadian dollar could potentially lead to higher interest rates in Canada. This is because a weaker currency can lead to higher inflation, as imports become more expensive and businesses may pass on the cost to consumers. In turn, higher inflation can lead to higher interest rates as central banks may raise rates to control inflation further.