CIBC notes that there has recently been an aggressive increase in expectations of a hawkish Federal Reserve, with markets pricing in a Fed rate hike of at least 0.25% in March.

With a rate hike already a foregone conclusion, the bank expects dollar strength to take a pause in the short term.

“With the market already pricing the Fed’s first move as aggressive and long US dollar positions being the consensus forecast, we expect a period of consolidation in the near term before the dollar starts to rise again.”

CIBC expects there will be a number of more rate hikes in 2023, triggering a new round of dollar buying.

The bank adds: “As we move through this year, we expect the market to add room for further Fed rate tightening beyond 2023. This should support broad-based US dollar strength.”

As for the ECB, CIBC notes that the more hawkish voices at the central bank have received some support given the sharp rise in inflation to record levels since the euro was introduced in 1999. Still, CIBC expects the dovish members of the committee to maintain control.

“We expect the doves, led by President Lagarde and Chief Economist Lane, to remain at the helm.”

In this context, the bank expects overall yield spreads to undermine the single currency:

“We remain unconvinced of the risk of early ECB action and believe a more dovish central bank is likely to keep the euro under pressure.”

CIBC also notes that the euro’s recovery this year has still been modest:

“The inability to break through the midpoint of the trading range seen over the past two years at 1.1492 supports our view of euro weakness.”

Market positioning has changed, with speculators now taking long positions, but CIBC does not expect this optimism to be sustained – “The lack of growth in the payrolls data indicates that short euro positions will rebound as the currency heads towards 1.10.”

The Euro to Dollar (EUR/USD) exchange rate is forecast to consolidate near the 1.10 area.

Doubts about Bank of Canada policy continue

CIBC has been consistently skeptical over the past few months that the Bank of Canada (BoC) would meet market expectations, and it hasn’t changed its mind.

The bank notes: “Economic indicators do not support the market’s view that the Bank of Canada will outperform the Fed.”  

CIBC believes it is unlikely that the Bank of Canada will be capable of aggressive tightening, especially given the domestic debt burden, “Debt-burdened Canadian households require a cautious approach to raising rates to avoid squeezing too much discretionary spending out of the economy.”

The bank expects the Canadian dollar to weaken, but it anticipates that the USD/CAD exchange rate will find support from the current level of oil prices.

He adds: “To break through the 1.30 CAD mark, we would need a significant decline in crude oil prices.”

Support for commodity currencies

While CIBC is generally bearish on the Canadian dollar, it has a more constructive outlook for other commodity currencies.

The bank’s analysts expect the Reserve Bank of Australia to raise interest rates later this year, “As with other currencies, the best gains are often seen in the early stages of pricing in these increases.”

In this context, CIBC expects active buying of the Australian dollar on dips, particularly against sterling: “We want to be buyers on Australian dollar weakness, particularly against other major currencies, including sterling, in preference to the US dollar.”

CIBC also expects the Reserve Bank of New Zealand’s (RBNZ) series of rate hikes to support the New Zealand dollar.

The bank notes: “As the market begins to refocus on New Zealand data and the likely path of RBNZ policy tightening, and we expect the rate to reach 2.00% in Q1 next year, we see support for NZD/USD.”

The bank expects limited upside, although AUD and NZD forecasts have been revised down slightly.

Sterling will pull back but forecasts revised upwards

CIBC expects sterling as a whole to lose ground. “We would not be surprised if consumer spending is threatened by a fall in disposable income.”

The bank expects the decline in spending to contribute to the Bank of England falling short of market expectations on interest rates. CIBC expects rates to be at 0.50% by mid-2022, compared to market expectations of around 0.75%.

CIBC notes that the change in expectations will provide support for sterling.

CIBC also expects UK fundamentals to be fragile, which will weaken support for the currency:

“Political uncertainty in the UK will remain evident and the state of the UK current account deficit remains a cause for concern if hot money inflows are threatened, suggesting GBP/USD remains negative mid-year.”

However, CIBC has raised its forecast for 2022 and does not forecast the Pound to Dollar (GBP/USD) exchange rate to retreat below 1.3000, while the Euro to Pound (EUR/GBP) exchange rate remains in a narrow range.