U.S. dollar seems unstoppable November 2014

November 2014
U.S. dollar seems unstoppable

With the end of the Fed’s debasement policies, the U.S. dollar now seems unstoppable. While rate hikes are
still several months away, markets may not wait that long, more so if U.S. economic data remains strong. Rate
expectations should move higher over the coming months, helping maintain the greenback’s momentum, more
so with both the euro and the yen under pressure from central bank policies.

The European Central Bank’s liquidity injections via purchases of covered bond and asset-backed securities
have proven to be too little too late. Monetary policy transmission channels remain blocked as evidenced by
still-contracting credit which is putting a damper on investment and consumption spending, and contributing to
the stagnation of the eurozone economy. With deflation knocking at the door, expect the ECB to keep the
money taps open for the next few years as it attempts to boost the economy and hence prices. We have made
room for further depreciation, expecting EURUSD to drop to 1.15 by the end of next year.

Abenomics switched gears in October with the Bank of Japan deciding to increase its asset purchases to the
amount of 80 trillion yen per year, i.e. up by 10 trillion/year. Japan’s public pension reserve fund also
announced that it will increase its allocation of foreign stocks and bonds. Those measures should maintain
pressure on the yen to depreciate, and we have accordingly pushed our end-of-2015 USDJPY forecast to 120.

In light of persistently dovish signals from the central bank, we have pushed to the last quarter of 2015 the
timing for when the Bank of Canada will resume rate hikes. The Canadian dollar will therefore be under
pressure, more so with the Fed starting to normalize monetary policy next year. We now expect USDCAD to
reach as high as 1.17 in 2015, i.e. a loonie worth close to 85 cents U.S.
Stéfane Marion/Krishen Rangasamy
NBF Currency Outlook*
Current
2014Q4
2015Q1
2015Q2
2015Q3
2015Q4
31-Oct-14
USDCAD
US cents per CAD
1.13
0.89
1.12
0.90
1.13
0.89
1.15
0.87
1.17
0.86
1.15
0.87
EURUSD
1.25
1.25
1.22
1.19
1.17
1.15
USDJPY
112
112
114
116
118
120
AUDUSD
0.88
0.87
0.85
0.84
0.83
0.82
GBPUSD
1.60
1.60
1.59
1.58
1.57
1.57
USDCNY
6.11
6.11
6.10
6.09
6.10
6.09
AUDCAD
1.00
0.97
0.96
0.97
0.97
0.94
* forecasts for end of period
Source: NBF Economics and Strategy
FOREX
Fed officially ends QE
The U.S. dollar has room to run, more so with the
end of the Fed’s debasement policies. So confident is
the FOMC about the economy that it decided at its
October meeting to withdraw some stimulus by
ending its long-running QE program. The Fed even
tweaked its forward guidance a bit by saying that
while the fed funds rate should remain low for a
“considerable time”, hikes could happen sooner or later
depending on developments on the employment and
inflation fronts. Based on the dollar’s surge after the
announcement, markets seem to think hikes are
coming sooner rather than later. Even speculators
have taken USD long positions to the highest ever.
highlighted with 13 of the 130 participant banks found
to have a capital shortfall ― those banks will have
nine months to cover the capital shortfall ― and with
non-performing exposures estimated at €879 bn, or
18% higher than what was initially thought. In other
words, don’t expect the transmission channels of
monetary policy to be unblocked anytime soon. Bank
balance sheets generally remain weak, which
explains the continued decline in credit. The third
quarter of 2014 saw the eleventh straight decline in
loans to non-financial corporations, and the fifth drop
of household credit in the last six quarters.
Eurozone: Credit contracted again in Q3
MFI loans to households and non-financial corporations
5.4
U.S.: Speculative USD longs at all-time high
2
1
0
-1
-2
-3
-4
-5
-6
-7
-8
-9
4.8
4.6
contracts
4.4
4.2
50,000
4.0
40,000
Non-financial
corporations
3.8
3.6
30,000
3.4
20,000
3.2
3.0
10,000
2.8
0
03
04
05
06
07
08
09
10
11
12
13
Households
Non-financial
corporations
14
NBF Economics and Strategy (data via Eurostat)
-10,000
-20,000
-30,000
q/q % chg. saar
Households
5.0
Non-commercial net long USD positions, monthly average
60,000
€ trillion
5.2
Oct.
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
NBF Economics and Strategy (data via Bloomberg)
Optimism about the U.S. economy, and hence the
case for tighter monetary policy, has been reinforced
by an improving labour market which, so far this year,
has created an average of 220K private sector
jobs/month, the best start of the year since 1998.
GDP growth numbers have also been rock solid with
the U.S. economy growing at an annualized pace of
4.1% over the Q2-Q3 period, the best two-quarter
performance since 2003. While growth should soften
in Q4 after the scorching hot last couple of quarters, it
should remain well supported next year by an
invigorated private sector. All told, conditions are in
place for the U.S. dollar to appreciate against most
major currencies through next year.
With the lack of credit putting a damper on
investment and consumption spending, it’s no
wonder the eurozone economy continues to
stagnate. GDP growth for Q3 is slated to be weak
again, and the unemployment rate remains near
record highs. The ECB’s liquidity injections via
purchases of covered bond and asset-backed
securities have proven to be too little too late. The
annual headline inflation rate is near 2009 lows, while
the string of sub-1% annual core inflation rates (14
consecutive months now) is unprecedented. So much
so that inflation expectations are now the lowest on
records.
Eurozone: Inflation expectations continue to fall
CPI excluding energy, food, alcohol and tobacco
2.8
2.6
2.4
2.2
Euro slide not over
After several months of decline, the euro stabilized
somewhat in October. Perhaps markets found
comfort in the European Central Bank’s stress test
results which showed the largest commercial banks
having sufficient capital to weather a downturn. But
ongoing banking problems were nonetheless
2.0
10-year inflation swaps
y/y % chg.
3.0
Annual core inflation at or below
1% for fourteen straight months,
i.e. longest streak on records ...
ECB target
... causing inflation expectations
to fall to lowest ever
2.6
2.4
1.8
2.2
1.6
2.0
1.4
%
2.8
1.8
1.2
1.6
1.0
1.4
0.8
0.6
14 consecutive months at or below 1%
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
1.2
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
NBF Economics and Strategy (data via Eurostat, Bloomberg)
2
FOREX
With deflation knocking at the door, expect the ECB
to keep the money taps open for the next few years
as it attempts to boost the economy and hence
prices. The central bank aims to grow its balance
sheet to 2012 levels, i.e. €1 trillion higher than
currently, and that should keep the euro under
pressure. We have made room for further
depreciation, expecting EURUSD to drop to 1.15 by
the end of next year.
Western Canada Select (the price received by our oil
exporters), have helped. So much so that the WCS
price drop (in C$) this quarter is set to be much
smaller than that of the more widely watched WTI.
Canada: Oil exporters partly protected from price slump
WTI in US$ versus WCS in C$
Quarterly price changes for WTI and WCS oil
WTI
112 $/barrel
30
WTI in US$
108
25
104
100
92
WCS in C$
15
88
10
84
80
Abenomics moved up a gear with the announcement
at the end of October of two important measures. The
Bank of Japan decided to increase its asset
purchases to the amount of 80 trillion yen per year,
i.e. up by 10 trillion/year. The decision wasn’t
unanimous with just over half of the members
backing the extra stimulus. On the same day, Japan’s
public pension reserve fund announced that it will
double its allocation of stocks to 50% (25% each for
domestic and foreign stocks), and increase its
allocation of foreign debt to 15%, at the expense of
domestic bonds whose allocation was cut to just
35%. Those measures should maintain pressure on
the yen to depreciate, and we have accordingly
pushed our end-of-2015 USDJPY forecast to 120.
Bank of Canada stance
continue to weigh on loonie
C$
... but damage to Canadian oil
exporters has been
cushioned by C$ depreciation
and narrowing spread
20
96
Abenomics switches gear
Spread
%
will
The Canadian dollar continues to face headwinds
generated by the greenback’s ascent. In October,
USDCAD averaged over 1.12 for the first time since
2009. The currency’s depreciation continued despite
a strong employment report ― the Labour Force
Survey indicated 74K jobs were created in the prior
month ― and an annual core inflation rate remaining
stubbornly above 2%. What hurt the loonie was its
petro-currency status, as sinking world oil prices took
the Canadian currency down ― Brent fell to its lowest
since 2010 while WTI fell to a two-year low.
5
76
72
0
68
WCS in C$
-5
64
Both WTI and WCS prices
have plummeted recently ...
60
56
52
Jan 13
Apr 13
Jul 13
Oct 13
Jan 14
Apr 14
Jul 14
-10
-15
Oct 14
* Based on October readings
NBF Economics and Strategy (data via Datastream)
14Q1
14Q2
14Q3
14Q4
est.*
Non-energy commodities are also not doing too
badly, with forestry and agricultural producers
receiving C$ prices that are still elevated by historic
standards. Those developments do not suggest a
major economic slowdown or fiscal problems for
Ottawa and the provinces.
Of course, oil prices could sink further over the
coming months, although we’re not particularly
pessimistic on that front. That’s because we believe
the recent oil plunge was not due to demand. Indeed,
the global economy continues to grow thanks to
support from a soaring U.S. but also from emerging
economies where factory activity remains in
expansion mode as evidenced by above-50
manufacturing purchasing managers indices in
countries like Mexico, India, Indonesia, Taiwan,
Vietnam, and of course China. The latter’s petroleum
imports also remain close to all-time highs,
something one wouldn’t expect to see if growth was
faltering.
China: Commodity demand still growing
Crude petroleum volume imports
index
y/y % chg.
40
30
While slumping oil prices are clearly not good news,
that’s not to say all is gloom and doom for Canada.
The overall economic outlook remains positive not
only due to the U.S. resurgence (which will continue
to support overall exports), but also because the
impacts of slumping oil prices have been cushioned
somewhat. The stabilizing impacts of the weakening
Canadian dollar and a narrowing spread, i.e. the
difference between West Texas Intermediate and
Change (R)
20
10
2,600
2,400
2,200
2,000
1,800
1,600
1,400
1,200
1,000
800
0
-10
Level (L)
04
05
06
07
08
09
10
11
12
13
14
NBF Economics and Strategy (data via Datastream)
3
FOREX
Downward price pressures seem to be coming from
the supply side. Thanks to U.S. energy boom,
OPEC’s grip on the global oil market has been
significantly diminished. True, Saudi Arabia, the
biggest swing producer, may ramp up output and cut
prices in an attempt to regain market share,
something that would further depress oil prices. But a
price war will be costly for the kingdom and cap its
ability to fund the country’s increased military
involvement in the fight against mounting regional
threats.
hikes much beyond that without risking its credibility
as an inflation-targeting central bank. There are
already question marks about the central bank’s
abilities to gauge actual slack in the economy ― the
BoC itself admitted to that fact in its MPR ― and
hence inflation. The fact that core inflation this year
has been consistently hotter than BoC estimates
suggests the central bank may be overstating the
actual slack in the economy.
Canada: BoC raises forecasts for core inflation
Core CPI forecasts by Bank of Canada
In our view, oil is a lesser threat to the loonie than the
Bank of Canada’s stance. The central bank has kept
a persistently dovish message in recent months and
will continue doing so over the next few quarters. The
latest Monetary Policy Report showed the central
bank significantly downgrading its 2015 global growth
forecasts, with the BoC saying that the world
economy is in worse shape than it was back in July.
The central bank’s assessment of the domestic
economy was also far from encouraging. While the
BoC acknowledged the ongoing recovery of the
export sector, it said the latter was still being
restrained by the destruction of capacity during the
last recession, particularly in the manufacturing
sector. The BoC was also downbeat about business
investment, saying the latter “might be delayed
relative to what would be expected in a normal cycle”.
All in all, based on its assessment that there is still
“considerable excess capacity” in the Canadian
economy, the central bank thinks that continued
monetary policy stimulus is needed.
The Bank of Canada doesn’t want to repeat policy
errors of the ECB and the Riksbank, both of which
have backpedalled in recent years due to deflation
concerns after having prematurely raised interest
rates. So, the BoC will continue erring on the side of
caution. The central bank’s stance has changed
significantly with new leadership. Carney’s policy of
“leaning” (via a tightening bias) to address longerterm threats to growth such as household debt
accumulation, has now been supplanted by Governor
Poloz’s emphasis on boosting short-term growth via
low interest rates and a cheap loonie. That shift has
been a clear negative for the Canadian dollar and will
continue to be so for a while.
In light of persistently dovish signals from the central
bank, we have pushed to the last quarter of 2015 the
timing for when the Bank of Canada will resume rate
hikes. Lower food and energy prices will give the
central bank some breathing room for the next few
quarters. But we doubt the central bank can delay
2.15
2.10
2.05
2.00
1.95
1.90
1.85
1.80
1.75
1.70
1.65
1.60
1.55
1.50
1.45
1.40
1.35
y/y % chg.
October MPR
July MPR
April MPR
14Q3
14Q4
15Q1
15Q2
15Q3
15Q4
16Q1
16Q2
16Q3
16Q4
NBF Economics and Strategy (data via Bank of Canada)
If, as we expect, GDP growth accelerates to 2.5%
next year, i.e. another year of above-potential growth,
the output gap will close faster than the “mid-2016”
timeline estimated by the central bank. So, while we
now expect the loonie’s dip to be a bit more
pronounced in the second half next year (because of
the delay to rate hikes), we are maintaining our 1.15
end-of-2015 target for USDCAD, expecting the BoC
to tighten monetary policy late that year.
Improving yields will help the loonie late in 2015, but
so will Ottawa’s first budget surplus in years which
should reassure foreign investors about Canada’s
ratings and growth outlook. Federal fiscal stimulus
provides upside potential for the economy next year.
Canada: Budget surplus perhaps as early as this fiscal year
Budget balance
C$ bn
10
5
?*
0
Actual
2014
Budget
-5
-10
-15
2014
Budget
-20
2013-14
2014-15
* 2014 budget estimate for FY2014-15 adjusted to take into account upside surprise in prior fiscal year (i.e. $10.7 bn smaller deficit)
NBF Economics and Strategy (data via Public Accounts of Canada 2014)
4
FOREX
Annex
Euro
Canadian dollar
1.7
1.10
1.6
1.05
1.00
1.5
0.95
1.4
0.90
1.3
0.85
1.2
0.80
1.1
0.75
1.0
0.70
0.9
0.8
0.65
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
0.60
1994
1996
1998
Japanese yen
1.15
140
1.05
135
1.00
130
2004
2006
2008
2010
2012
2014
0.95
2008
2010
2012
2014
2008
2010
2012
2014
1.10
125
0.90
120
0.85
115
110
0.80
0.75
105
0.70
100
95
0.65
90
0.60
85
0.55
80
0.50
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
0.45
1994
1996
1998
British pound
2.1
2.0
1.9
1.8
1.7
1.6
1.5
1.4
1994
1996
1998
2000
2002
2004
2006
2000
2002
2004
2006
Chinese yuan
2.2
1.3
2002
Australian dollar
150
145
75
2000
2008
2010
2012
2014
8.8
8.6
8.4
8.2
8.0
7.8
7.6
7.4
7.2
7.0
6.8
6.6
6.4
6.2
6.0
5.8
5.6
1994
1996
1998
2000
2002
2004
2006
NBF Economics and Strategy (data via Datastream)
5
FOREX
ECONOMICS AND STRATEGY GROUP
514-879-2529
Stéfane Marion
Chief Economist & Strategist
stefane.marion@bnc.ca
Paul-André Pinsonnault
Senior Fixed Income Economist
paulandre.pinsonnault@bnc.ca
Krishen Rangasamy
Senior Economist
krishen.rangasamy@bnc.ca
Marc Pinsonneault
Senior Economist
marc.pinsonneault@bnc.ca
Matthieu Arseneau
Senior Economist
matthieu.arseneau@bnc.ca
General: National Bank Financial Markets is a business undertaken by National Bank Financial Inc. (“NBF”), an indirect wholly owned subsidiary of
National Bank of Canada, and a division of National Bank of Canada.  This research has been produced by NBF. National Bank of Canada is a public
company listed on Canadian stock exchanges.  The particulars contained herein were obtained from sources which we believe to be reliable but are not
guaranteed by us and may be incomplete. The opinions expressed are based upon our analysis and interpretation of these particulars and are not to be
construed as a solicitation or offer to buy or sell the securities mentioned herein.  Canadian Residents: In respect of the distribution of this report in
Canada, NBF accepts responsibility for its contents. To make further inquiry related to this report or effect any transaction, Canadian residents should
contact their NBF Investment advisor.  U.S. Residents: With respect to the distribution of this report in the United States, National Bank of Canada
Financial Inc. (NBCFI) is regulated by the Financial Industry Regulatory Authority (FINRA) and a member of the Securities Investor Protection Corporation
(SIPC). This report has been prepared in whole or in part by, research analysts employed by non-US affiliates of NBCFI that are not registered as
broker/dealers in the US. These non-US research analysts are not registered as associated persons of NBCFI and are not licensed or qualified as
research analysts with FINRA or any other US regulatory authority and, accordingly, may not be subject (among other things) to FINRA restrictions
regarding communications by a research analyst with the subject company, public appearances by research analysts and trading securities held a
research analyst account. All of the views expressed in this research report accurately reflect the research analysts’ personal views regarding any and all
of the subject securities or issuers. No part of the analysts’ compensation was, is, or will be, directly or indirectly, related to the specific recommendations
or views expressed in this research report. The analyst responsible for the production of this report certifies that the views expressed herein reflect his or
her accurate personal and technical judgment at the moment of publication. Because the views of analysts may differ, members of the National Bank
Financial Group may have or may in the future issue reports that are inconsistent with this report, or that reach conclusions different from those in this
report. To make further inquiry related to this report, United States residents should contact their NBCFI registered representative.
 UK Residents: In respect of the distribution of this report to UK residents, National Bank Financial Inc. has approved the contents (including, where
necessary, for the purposes of Section 21(1) of the Financial Services and Markets Act 2000). National Bank Financial Inc. and/or its parent and/or any
companies within or affiliates of the National Bank of Canada group and/or any of their directors, officers and employees may have or may have had
interests or long or short positions in, and may at any time make purchases and/or sales as principal or agent, or may act or may have acted as market
maker in the relevant securities or related financial instruments discussed in this report, or may act or have acted as investment and/or commercial banker
with respect thereto. The value of investments can go down as well as up. Past performance will not necessarily be repeated in the future. The
investments contained in this report are not available to retail customers. This report does not constitute or form part of any offer for sale or subscription of
or solicitation of any offer to buy or subscribe for the securities described herein nor shall it or any part of it form the basis of or be relied on in connection
with any contract or commitment whatsoever. This information is only for distribution to Eligible Counterparties and Professional Clients in the United
Kingdom within the meaning of the rules of the Financial Conduct Authority. National Bank Financial Inc. is authorised and regulated by the Financial
Conduct Authority and has its registered office at 71 Fenchurch Street, London, EC3M 4HD. National Bank Financial Inc. is not authorised by the
Prudential Regulation Authority and the Financial Conduct Authority to accept deposits in the United Kingdom.  Copyright: This report may not be
reproduced in whole or in part, or further distributed or published or referred to in any manner whatsoever, nor may the information, opinions or
conclusions contained in it be referred to without in each case the prior express written consent of National Bank Financial.