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The Canadian dollar could hold on to Q1 gains into mid-year, but H2 will see them unwind as the Fed becomes more hawkish, economists at CIBC Capital Markets report.

Fed to signal a more sustained escalation in inflationary pressures

“The enthusiasm around crude prices that drove those gains has since been tempered as OPEC+ has announced that it will begin a partial rollback of supply cuts over the next three months. Combined with a USD that is now broadly back in favor with investors, CAD no longer looks set to appreciate, and will likely remain steady into mid-year.”

“With the third wave forcing fresh shutdowns across Canada, the economic performance gap to the US is set to be magnified in the coming months, as the US is miles ahead of Canada in terms of fiscal stimulus, vaccinations, and re-openings. That will translate into a later closing of economic slack in Canada, even with an acceleration in growth over the summer months as consumer spending surges upon re-openings.”

“While the Bank of Canada might nudge its earlier timetable for rate hikes up a bit, its messaging will look dovish relative to what’s now priced in, which would entail a hike in mid-2022. In contrast, both Fed talk and market expectations will be bringing forward the timetable for US rate hikes as the recovery progresses. A shift to a more hawkish tone from the Fed will pave the way for a weaker Canadian dollar in H2 and through 2022.”

“Look for USD/CAD to trade in the 1.30-1.34 range next year. That level will be more constructive for exports, as the experience of the last decade suggests that Canada isn’t competitive with a sub-1.30 dollar-Canada exchange rate.”