Forex

Economics and Strategy

October 2019

Highlights
By Stéfane Marion / Krishen Rangasamy

 The outcome of U.S.-China trade talks will, to a large extent, influence world currencies in October. If, as we expect, the two
superpowers agree to a truce in their ongoing trade war, that could prompt risk taking by investors and hence take some
steam out of the U.S. dollar.

 It’s no secret Europe, with its relatively high global value chain participation, has been affected the most by the disruption
of trade flows. So, a truce (if any) in the ongoing U.S.-China trade war, would likely benefit the euro. That said, the eurozone
and its currency face the possibility of additional shocks, e.g. a hard Brexit at the end of the month and potential U.S. tariffs
on imports of European products. But our base-case forecast of the Eurozone avoiding a recession, and hence for EURUSD
not collapsing, assumes that policymakers, having seen damaging impacts of tariffs (globally) and Brexit (on the UK), would
seek conciliation rather than succumb to their populist tendencies. 

 The Canadian dollar’s performance will depend not only on U.S.-China trade talks but also on the Bank of Canada’s
monetary policy decision and, to a lesser extent, the outcome of the federal elections later this month. If we’re right about
an upcoming truce in the U.S.-China trade war, oil prices would get a lift as investors become less pessimistic about the
global economy and prompt markets to reduce expectations of Bank of Canada rate cuts, giving a lift to the loonie in the
process. We are keeping unchanged our end-of-2019 forecast of 1.30 for USDCAD.  

NBF Currency Outlook*

Current
4-oct-19 2019Q4 2020Q1 2020Q2 2020Q3 2020Q4
USDCAD 1.33 1.30 1.32 1.34 1.35 1.35
US cents per CAD 0.75 0.77 0.76 0.75 0.74 0.74
EURUSD 1.10 1.12 1.11 1.10 1.09 1.09
USDJPY 107 109 111 112 110 108
AUDUSD 0.68 0.69 0.68 0.67 0.65 0.65
GBPUSD 1.23 1.25 1.23 1.22 1.20 1.20
USDCNY 7.15 6.90 6.85 6.80 6.75 6.70
USDMXN 19.59 19.40 19.20 19.40 19.60 19.60
*Forecasts for end of period
NBF Economics and Strategy

1
Forex
Economics and Strategy

U.S. dollar still rules world currency markets

For years there has been talk of the U.S. dollar being supplanted shocks including the sovereign debt crisis, political instability and
as the world’s reserve currency by other major currencies the persistence of slow economic growth.
including the euro and China’s renminbi. To support the notion of
the greenback eventually losing its status as the world’s … USD still reigns supreme in global currency markets
Share* of currency in total OTC foreign exchange turnover in April of each year
dominant currency arguments were made including de-
91
dollarization (e.g. economic zones attempting to settle trade of % %
90
goods & services in currencies other than the USD), the rise of the 89
eurozone and China as global powerhouses, America’s shrinking U.S. dollar (R) 88
87
share of global GDP, and central bank diversification.
86
85
Diversification has indeed taken place if latest IMF data on its 40
84
Currency Composition of Official Foreign Exchange Reserves 35 Euro (L) 83

(COFER) are any guide. The USD’s share of COFER’s allocated 30 82

81
reserves fell in the second quarter to just 61.6%, the lowest in over 25
Japanese yen (L)
five years. And roughly half of the four percentage point decline 20

15
of the USD’s share since 2015 can be attributed to the IMF’s British pound (L)
10
inclusion of China’s renminbi in COFER. Swiss Franc (L)
Australian dollar (L)
5 Canadian dollar (L)
Chinese renminbi (L)
While U.S. dollar’s share of allocated reserves at IMF is declining … 0
1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 2019
IMF Composition of Official Foreign Exchange Reserves
* Because two currencies are involved in each transaction, the shares of all currencies should add up to 200%
NBF Economics and Strategy (data via Bank of International Settlements)
11.5
% US$ trillion
11.0
Allocated reserves (R) 10.5 All told, the U.S. dollar remains the currency of choice for investors
10.0 worldwide. And because of its universality, the USD is often
9.5
9.0 regarded as a safe haven currency. This characteristic explains
8.5
the greenback’s surge in times of stress or concern among
8.0
7.5 investors. The USD has, however, done well even outside periods
7.0
66 6.5
of stress. Note that both the trade-weighted U.S. dollar and MSCI
65
All-Country World index are near all-time highs. Diverging
64
U.S. dollar’s share of monetary policies explain in part the U.S. dollar’s strength in
allocated reserves (L)
63
recent months. The Federal Reserve, which has a meeting
62
scheduled at the end of the month, has already signaled it is
61
nearing the end of its easing cycle at a time when other major
60 Q2
central banks are expanding stimulus further. For now, markets
2015 2016 2017 2018 2019 don’t believe the Fed, with investors pricing in more than 70%
NBF Economics and Strategy (data via IMF COFER)
probability that rates will fall to 1.50% or lower by April. That’s a bit
aggressive in our view and as such the USD could find support
But that’s not to say the USD is losing its status as the world’s
next year if, as we expect, markets trim those expectations.
dominant currency. Note that allocated reserves in COFER
amounted to roughly US$11 trillion at the end of 2019Q2, a drop in U.S.: Markets expect additional interest rate cuts from the Fed
the bucket compared to what’s traded in global currency Target rate probabilities for April 2020 Fed meeting

markets. According to the Bank of International Settlements’ 40

% 37.4
latest Triennial Survey (which took a snapshot of global currency
35
trading in April 2019), trading in world foreign exchange markets
Markets pricing >70%
averaged a record $6.6 trillion/day. And the U.S. dollar was on 30 probability of rates 27.8
falling to 1.50% or lower
one side of 88.3% of all FX trades, its highest share since 2001. 25
China’s renminbi increased its share of global FX turnover, but 21.2
20
only marginally. The fact that China’s capital account is not fully
convertible remains an obstacle to the renminbi gaining more 15

influence on world currency markets ─ controls are still in place 8.7

10
with regards to transactions in financial assets and exchange
5 4.0
rates. The euro, for its part, has seen its share of global FX
0.9 Current
turnover decline since 2001. The euro’s inability to knock off the 0
50-75 75-100 100-125 125-150 150-175 175-200
U.S. dollar off its perch is perhaps due to investors and currency Target rate in basis points
traders questioning its viability as a reserve currency after several NBF Economics and Strategy (data via CME Group)

2
Forex
Economics and Strategy

However, this is not to say the greenback can’t see occasional World: Global value chain participation is higher in Europe
% of exports, sum of forward and backward linkage
bouts of weakness, particularly over the near term. And here
80
we’re thinking of the possibility of a truce in the ongoing U.S.- %

China trade war being agreed by the two economic superpowers 70

later this month, something that could prompt risk taking by 2000 Latest
investors. 60

50

40

Euro hammered by trade war 30

A meaningful truce, if any, would likely benefit the euro. It’s no 20

secret Europe, with its relatively high global value chain
participation, has been affected the most by the disruption of 10

trade flows. Germany for example, may already be in technical

0
recession after its economy contracted in Q2 and possibly in the Europe Asia Americas
NBF Economics and Strategy (data via IMF June 2019: Trade Tensions, Global Value, Chains, and Spillovers)
third quarter as well. Germany’s woes are weighing on the
Eurozone, the latter’s composite purchasing managers indices
suggesting the common currency area is growing at its slowest
pace in years.
Elections and the Bank of Canada
Eurozone: Economy deteriorated further in Q3
Real GDP versus Markit composite purchasing managers index The Canadian dollar is one of only two major currencies to be up
3.4 57.5 against USD so far in 2019. An eventful October has potential to
y/y % chg.
3.2 57.0 cause significant movement in the currency. Investors will, as
3.0 56.5 usual, be watching crucial Canadian economic data such as
2.8 56.0 employment, GDP and inflation to gauge Q3 activity. Data will
Composite PMI (R)
2.6 55.5 point to a deceleration of GDP growth, although nobody should
2.4 55.0 be surprised by this considering the massive and unsustainable
2.2 54.5 3.7% annualized growth print in the second quarter. Similarly,
2.0 54.0 employment creation is likely to moderate after 304K jobs were
1.8 53.5 created in the first eight months of the year, the best
1.6 Real GDP (L) 53.0
performance since 2002.
1.4 52.5

1.2 52.0 Canadian dollar has performed relatively well this year
Appreciation versus U.S. dollar since start of 2019
1.0 51.5

0.8 51.0
Q3
Japanese yen
2016 2017 2018 2019
average
NBF Economics and Strategy (data via Refinitiv) Canadian dollar
Mexican peso
That has forced the European Central Bank to ease an already- Taiwan dollar

loose monetary policy, putting further pressure on EURUSD. In Singapore dollar

September, the ECB lowered the interest rate on its deposit Swiss franc

facility further into negative territory, made its forward guidance British pound

dependent on achieving inflation objectives (i.e. no formal Euro

Danish krone
expiration date), and restarted Quantitative Easing (as from
Australian dollar
November the central bank will purchase assets at a pace of €20
Brazilian real
billion/month).
South African rand

The Eurozone faces the possibility of additional shocks, e.g. a Norwegian krone %

hard Brexit ─ which may happen at the end of the month unless -6 -5 -4 -3 -2 -1 0 1 2 3
NBF Economics and Strategy (data via Bloomberg)
UK Prime Minister Johnson can strike a deal with the EU or request
another extension, and potential U.S. tariffs on imports of But of utmost interest to investors will be the outcome of the
European products. But our base-case forecast of the Eurozone federal elections on October 21st especially because of its
avoiding a recession, and hence for EURUSD not collapsing, implications for the 2020 economic outlook.  Above-potential
assumes that policymakers, having seen damaging impacts of GDP growth next year is possible if federal politicians are able to
tariffs (globally) and Brexit (on the UK), would seek conciliation deliver on their campaign promises for significant fiscal
rather than succumb to their populist tendencies. expansion. But if current polls are correct and the elections

3
Forex
Economics and Strategy

deliver only a minority government, the effectiveness of fiscal
policy may be blunted by slow implementation or worse, gridlock.
The Canadian dollar could suffer as a result.
Later in the month, on October 30th, the Bank of Canada will
decide on monetary policy and release updated economic
projections via the Autumn edition of its Monetary Policy Report
(MPR). The BoC will probably raise its 2019 GDP growth forecast
for Canada (was 1.3% in last July’s MPR) to reflect the Q2 surprise.
The central bank’s 2020 projections for Canada will depend not
on the results of the federal elections ─ the BoC tends to
incorporate fiscal measures in its forecasts only when they are
officially announced ─ but on the outcome of the much-
anticipated U.S.-China trade talks. The latter will likely determine
the tone of the monetary policy statement. Based on our
assumption of a truce in the ongoing trade war, we expect the
central bank to keep the overnight rate unchanged. The BoC
needs not follow the Fed with rate cuts considering monetary
Longer-term, however, we’re less bullish about the loonie’s
prospects. Note that in the 12 months to July, Canadians have
bought more foreign securities than foreigners did Canadian
ones. It’s the first time since 2008 that Canada sees net outflows
(or negative net inflows) of portfolio investment on a twelve
month cumulative basis. That was largely a result of transactions
in bonds whose net outflows over the period were due to strong
demand by Canadians for foreign corporates and diminishing
appetite of foreigners for Canadian sovereigns. Recall that
Canada’s current account deficits have been financed in each of
the last 11 years by net inflows of portfolio investment. Absent
those net inflows, Canada will either have to run smaller current
account deficits (i.e. requiring a cheaper loonie) or find ways to
attract other types of foreign capital e.g. FDI.
Canada: Net portfolio inflows turn negative
Net portfolio investment flows, 12-month cumulative
C$ bn Inflows = Foreign net purchases of C$ bn
240

Canadian portfolio securities (R)

policy is already stimulative (the real overnight rate has been 200

negative for more than a decade now), higher-than-expected 160

120
GDP growth, rampant labour market, on-target inflation, and the
80
growing problem of household debt accumulation. But even with
40
a truce, don’t expect a hawkish statement from the central bank Outflows = Canadian net purchases
160 0
which will want to leave itself room to act should downside risks of foreign portfolio securities (R)
120 -40
materialize.
80
A U.S.-China truce may help lift oil prices, as investors become 40 Net portfolio inflows (L)
less pessimistic about the global economy. That could help the 0
= Inflows - Outflows

loonie over the near term, especially considering oil has been the In the 12 months to July, Canadians
-40
have bought more foreign securities
main driver of the currency in recent months. As such, we are than foreigners did Canadian ones
-80 Jul.
keeping unchanged our end-of-2019 forecast for 1.30 for 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

USDCAD. NBF Economics and Strategy (data via Statistics Canada)

Oil rather than interest rate spreads has been main driver of loonie lately
100-day correlation between USDCAD, WTI oil price and 2-year Canada-U.S. interest rate differential

0.65

0.60

0.55

0.50

0.45

0.40

0.35 WTI

0.30

0.25

0.20

0.15

0.10
Interest rate
0.05 spreads

0.00
2017q1 2017q2 2017q3 2017q4 2018q1 2018q2 2018q3 2018q4 2019q1 2019q2 2019q3 2019q4

NBF Economics and Strategy (data via Refinitiv)

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Forex
Economics and Strategy

Annex
Euro Canadian dollar
1.7 1.65
1.60
1.6
1.55
1.50
1.5
1.45
1.4 1.40
1.35
1.3
1.30
1.25
1.2
1.20
1.1 1.15
1.10
1.0
1.05
1.00
0.9
0.95
0.8 0.90
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Japanese yen Australian dollar

140 1.15

135 1.10

130 1.05

125 1.00

0.95
120
0.90
115
0.85
110
0.80
105
0.75
100
0.70
95
0.65
90 0.60
85 0.55
80 0.50

75 0.45
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

British pound Chinese yuan

2.2 8.4

2.1 8.2

2.0 8.0

7.8
1.9
7.6
1.8
7.4
1.7
7.2
1.6
7.0
1.5
6.8
1.4
6.6
1.3 6.4

1.2 6.2

1.1 6.0
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Canadian Dollar*
Current
4-oct-19 2019Q4 2020Q1 2020Q2 2020Q3 2020Q4
USDCAD 1.33 1.30 1.32 1.34 1.35 1.35
EURCAD 1.47 1.45 1.46 1.48 1.47 1.47
CADJPY 80 84 84 83 81 80
AUDCAD 0.91 0.90 0.89 0.90 0.88 0.88
GBPCAD 1.64 1.62 1.62 1.64 1.62 1.62
CADCNY 5.36 5.31 5.21 5.07 5.00 4.96
CADMXN 14.69 14.94 14.59 14.45 14.50 14.50
*Forecasts for end of period
NBF Economics and Strategy

5
Forex
Economics and Strategy

Economics and Strategy

Montreal Office Toronto Office
514-879-2529 416-869-8598
Stéfane Marion Matthieu Arseneau Warren Lovely
Chief Economist and Strategist Deputy Chief Economist MD & Head of Public Sector Strategy
stefane.marion@nbc.ca matthieu.arseneau@nbc.ca warren.lovely@nbc.ca

Krishen Rangasamy Paul-André Pinsonnault Marc Pinsonneault

Senior Economist Senior Fixed Income Economist Senior Economist
krishen.rangasamy@nbc.ca paulandre.pinsonnault@nbc.ca marc.pinsonneault@nbc.ca

Kyle Dahms Jocelyn Paquet Angelo Katsoras

Economist Economist Geopolitical Analyst
kyle.dahms@nbc.ca jocelyn.paquet@nbc.ca angelo.katsoras@nbc.ca

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