1. Art and Diseño

February 2015
Competitive devaluation

The U.S. dollar continues to benefit from the divergence of monetary policy. The stronger U.S. economy has
raised the probability of rate hikes by the Fed at a time when several other major central banks have seemingly
adopted competitive devaluation strategies by not only increasing stimulus but also signalling their intent to
continue on that path. So, the greenback has room to run over the near to medium term. That said, we expect a
moderation in the rate of USD appreciation this year. Low inflation will cap the Fed’s abilities to significantly
tighten monetary policy, while some unwinding of the massive speculative long positions could also take some
steam out of the greenback.

The European Central Bank’s quantitative easing program, slated to start in March, is significant. While the
ECB’s balance sheet may not surpass the Fed’s in absolute terms, it will do so in relative terms ― as a
percentage of the size of the respective economies, the ECB’s balance sheet will be larger than the Fed’s.
Such currency debasement policies should hurt the euro. Recall that the trade-weighted U.S. dollar sank 18%
from peak to trough during the Fed’s own QE program.

The Canadian dollar has lost more than 20% of its value against the U.S. dollar in the last two years. That said,
the loonie’s decline hasn’t been as drastic against other currencies considering competitive devaluations by
other central banks. So, while the Bank of Canada said its surprise January rate cut was an “insurance policy”
against downside risks to inflation and financial stability, the loonie’s relative competitiveness and preservation
of market share may also have been at the back of Governor Poloz’s mind. We expect the BoC to deliver
another rate cut at its March meeting, something that should keep the Canadian dollar under pressure over the
near term. That’s not the say the loonie will remain on a downtrend. A recovery in oil prices should help offset
headwinds generated by unfavourable yields and provide some support to the Canadian dollar.
Stéfane Marion/Krishen Rangasamy
NBF Currency Outlook*
Current
2015Q1
2015Q2
2015Q3
2015Q4
2016Q1
1.24
0.80
1.26
0.80
1.27
0.79
1.28
0.78
1.27
0.79
1.25
0.80
EURUSD
1.15
1.14
1.13
1.12
1.10
1.10
USDJPY
117
118
120
122
125
125
AUDUSD
0.78
0.76
0.75
0.75
0.74
0.74
GBPUSD
1.51
1.50
1.49
1.48
1.47
1.47
USDCNY
6.26
6.27
6.28
6.28
6.29
6.29
AUDCAD
0.96
0.96
0.95
0.96
0.94
0.93
3-Feb-15
USDCAD
US cents per CAD
* forec asts for end of period
Source: NBF Economic s and Strategy
F
FOREX
X
A
Atypical surge
s
for greenbac
ck
Rec
cord speculative
e bets in favourr of U.S. dollar
Net lo
ong non-commercial positions
p
on USD
80
0,000
The trade-weig
ghted U.S. dollar has now
w seen gains
s
fo
or seven straight months, allowing it re
each its 2009
9
cyycle peak. Th
he more than
n 12% appre
eciation since
e
Ju
uly last year is
i impressive, more so con
nsidering thatt
su
uch gains are
e atypical outtside of a pe
eriod of crisis.
The last time the
t USD saw
w such a surg
ge was during
g
th
he global recession of 2008/2009 and, before that,,
th
he Asian finan
ncial crisis of 1998.
contracts
70
0,000
60
0,000
50
0,000
40
0,000
30
0,000
20
0,000
10
0,000
0
-10
0,000
-20
0,000
-30
0,000
U
U.S.
dollar surge
e atypical outside of a crisis
T
Trade
weighted U.S. dollar,
d
7-month change
20
18
16
14
12
10
8
6
4
2
0
-2
-4
-6
-8
-10
-12
%
1998
200
00
2002
2004
20
006
2008
2010
20
012
2014
Global recession
Asian financial crisis
1996
1996
NB
BF Economics and Strattegy (data via Datastream
m)
1998
Current surge
2000
2002
2004
2006
2008
2010
0
2012
2014
h the entire
Can the greenbacck’s surge exxtend through
5? To be sure
e, it now seem
ms easier for the Fed to
2015
surp
prise on the up
pside on rate
es. Markets ha
ave indeed
signiificantly trimm
med their exp
pectations abo
out the fed
fund s rate ― the
e fed funds ffutures now sshow rates
endi ng the year below 0.50%
%, i.e. not m
much of an
incre
ease from the
e current 0-0.2
25% range. T
That’s quite
dovissh compared
d to where FOMC particip
pants think
ratess should be b
by the end of tthe year.
NBF Economics and Strategy (data via Datastream)
This time, how
wever, the worrld economy doesn’t
d
seem
m
to
o be in crisis mode.
m
While global
g
growth
h is admittedly
y
no
ot stellar, parrtly due to co
ontinued stag
gnation in the
e
Eurozone and a softer eco
onomy in Chin
na (in light off
re
ebalancing efforts by Be
eijing), the overall
o
global
ou
utlook nonetheless remains positive. The world’s
s
la
argest econom
my, the U.S., is on track to grow this
s
ye
ear at the fastest
f
pace in a decad
de. Emerging
g
ecconomies sh
hould also continue
c
to benefit from
m
im
mproving U.S. demand, mo
ore competitiv
ve currencies
s
ag
gainst the USD,
U
and lo
ower oil pric
ces. Cheaperr
en
nergy is also
o helping keep inflation low, allowing
g
ce
entral banks in most ma
ajor economies to assistt
grrowth by keeping monetary
m
po
olicy highly
y
acccommodativ
ve.
So if it’s not crisis-related
d safe haven
n flows, whatt
exxactly is behind this USD surge? The divergence
d
off
m
monetary policy is clearrly a major driver. The
e
sttronger U.S. economy has
s raised the probability off
ra
ate hikes by the Fed at a time when several otherr
m
major central banks
b
have no
ot only loosen
ned monetary
y
po
olicy but also
o signalled their intent in continuing
c
on
n
th
hat path over the near to medium
m
term. Speculators
s
ha
ave also am
mplified the greenback’s ascent, via
a
re
ecord net long
g positions.
Markkets don’t se
eem to believve the FOMC
C, perhaps
due to the drag to the econo
omy that is exxpected to
oaring greenb
back. Indeed, exporters
com e from the so
are a
already starting to feel the
e pinch according to the
Fed’ s latest Beige Book. Also
o, the USD su
urge of the
past year could worsen the already milld inflation
outlo
ook. The annu
ual inflation ra
ate as measu
ured by the
PCE
E deflator in D
December was at its lowesst since the
2008
8/09 recessio
on, and that’ss partly due to sinking
enerrgy prices. Bu
ut prices havve been very mild even
exclu
uding transittory factors such as e
energy, as
evide
enced by the
e core PCE w
which showed an annual
inflattion rate of jjust 1.3% in December, the lowest
2
FOREX
since March last year. And given the negative impact
of the USD’s appreciation on import prices, odds are
that PCE inflation will remain low and well below the
Fed’s 2% target for the next several quarters.
Eurozone: ECB ramps up the printing press
Central bank balance sheet as a % of GDP
Central bank balance sheet
4.8
Forecast*
US$ trillion
34 %
32
Fed
4.4
4.0
3.6
28
26
ECB
24
U.S.: Import prices likely to contract this year
3.2
Trade-weighted U.S. dollar and import price index
2.8
20
2.4
18
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
-5
-6
-7
-8
y/y % chg.
Inverse axis
y/y % chg. -12
Import prices
ex-petroleum (L)
2005
2006
2007
2008
2009
2010
2011
-10
-8
-6
Trade-weighted USD -4
four-month lag (R) -2
0
2
4
6
8
10
12
14
16
18
20
2012
2013
2014 2015
NBF Economics and Strategy (data via Datastream)
All told, low inflation will cap the Fed’s abilities to
significantly tighten monetary policy. So, while the
USD has room to run in synch with diverging
monetary policies, we expect a moderation in the rate
of appreciation this year. Some unwinding of the
massive speculative long positions may also take
some steam out of the greenback.
ECB launches QE
22
16
2.0
Fed
14
1.6
12
1.2
10
8
0.8
0.4
...but will surpass the
Fed’s relative to the size
of the economy
30
ECB’s balance sheet will
remain smaller than the
Fed’s in absolute terms ...
Forecast**
ECB
6
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
*ECB’s QE at €60 bn/month from March 2015 to September 2016,
unchanged thereafter; EURUSD at 1.10 end-2015 and 1.05 end-2016
4
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
** ECB’s QE at €60 bn/month from March 2015 to September 2016, unchanged
thereafter; nominal GDP grows 2% in eurozone in both 2015 and 2016
NBF Economics and Strategy (data via Bloomberg)
January’s annual inflation rate of -0.6%, the lowest
since July 2009, wasn’t all about low energy prices.
Indeed, the annual core inflation rate was just 0.6% in
January, the lowest on records. The failure by the
zone’s governments to implement growth-friendly
reforms and policies should continue to cap
employment, growth and hence inflation. The political
uncertainties brought, yet again, by Greece, won’t
help either. All told, expect the ECB’s QE program to
be extended well beyond 2016. Such currency
debasement policies should hurt the euro. Recall that
the trade-weighted U.S. dollar sank 18% from peak to
trough during the Fed’s own QE program.
Eurozone: Heading towards deflation
Consumer price index
4.5
y/y % chg.
4.0
Having tried and failed over the last several years at
rekindling credit and economic growth by using
conventional measures, the European Central Bank
finally decided in favour of a more aggressive
approach. The ECB announced in January that it was
starting quantitative easing via a plan to purchase
€60 bn of private and public bonds per month on the
secondary market. The central bank intends to carry
out the program from March 2015 to September 2016
(i.e. taking total purchases to €1.1 trillion), although it
made clear the program could be extended past that
date or end sooner depending on whether or not
economic objectives are met. So, the QE program is
effectively open-ended. While the ECB’s balance
sheet may not surpass the Fed’s in absolute terms, it
will do so in relative terms ― as a percentage of the
size of the respective economies, the ECB’s balance
sheet will be larger than the Fed’s. Such drastic
action, while belated in our view, had to be taken
considering the mounting threat of deflation within the
Eurozone.
3.5
3.0
2.5
2.0
1.5
1.0
Core
0.5
0.0
-0.5
-1.0
00
01
02
03
04
05
06
07
08
09
10
11
12
13
Headline
14 15
NBF Economics and Strategy (data via Datastream)
Bank of Canada sinks loonie
The Canadian dollar has lost more than 20% of its
value against the U.S. dollar in the last two years.
Such a slump is unprecedented for the loonie. While
part of the decline was due to the strengthening USD,
and declining oil prices, the Bank of Canada’s
policies also explain part of the rout. The central
bank’s communications have been largely dovish
since Governor Poloz‘s arrival at the helm a year and
3
FOREX
half ago. And in January, the Bank of Canada took its
dovish stance a step further by dispatching a surprise
interest rate cut.
Loonie slump unprecedented
24-month change in value of C$ versus USD
35
%
30
25
20
15
10
5
0
-5
expected November GDP, provide the central bank
ample ammunition to support further stimulus. We,
accordingly, expect the BoC to deliver another rate
cut at its March meeting, something that should keep
the Canadian dollar under pressure over the near
term. That would also help partly restore the C$’s
competitiveness relative to other major currencies
that have also sunk due to loose monetary policies by
their respective central banks. Note that while the
loonie is at a multi-year low against the USD, its
decline hasn’t been as drastic against other
currencies including the yen, the Australian dollar and
Norwegian krone.
-10
-15
Loonie depreciation largely against USD
-20
Trade-weighted Canadian dollar
-25
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
132
index
128
NBF Economics and Strategy (data via Datastream)
Total
124
The central bank supported its decision by saying
that it is taking some insurance in light of downside
risks to inflation and financial stability brought by the
oil price collapse. The latter can indeed have
negative spillovers even beyond the oil patch. For
instance, the housing market could be vulnerable if
employment takes a hit from the expected
moderation
in
economic
growth.
Revised
employment data from Statistics Canada not only
show that employment last year was weaker, but the
dependence on Western Canada was even greater
than previously thought ― 84% of the jobs created
came from the four westernmost provinces (versus
71% before revisions). That’s bad news for the 2015
employment outlook because Western provinces are
unlikely to repeat the feat considering what happened
to energy prices.
Excluding
USD
120
116
112
108
104
100
96
92
2007
2008
2009
2010
2011
2012
2013
2014
NBF Economics and Strategy (data via Bank of Canada)
That’s not the say the Canadian dollar will remain on
a downtrend. In our view, the oil price collapse isn’t
commensurate
with
demand
and
supply
fundamentals. And with global demand continuing to
hold firm, we expect WTI oil to bounce back to
$60/barrel by the end of the year. That should help
offset headwinds generated by unfavourable yields
and provide some support to the Canadian dollar.
Canada: More bad news from the labour market
Employment creation according to
Labour Force Survey
400
thousands
2014 job creation by provinces, in thousands
350
70
250
60
Private
150
50
40
100
50
30
Total
0
20
-50
-100
10
-150
0
-200
-10
-250
-300
… and 84% of those jobs were in
Western Canada
80
300
200
-20
04
05
06
07
08
09
10
11
12
13
Oil price collapse does not reflect state of global economy
OECD leading economic indicators versus Brent oil price
Labour market created just
121K net new jobs last year ...
14
BC AB SK MB ON QC NB NS PE NL
NBF Economics and Strategy (data via Statistics Canada)
The string of bad data that came after the Bank of
Canada’s surprise decision, including the downward
revision to employment and the weaker-than-
102.5 Index
World (L)
102.0
101.5
OECD (L)
101.0
US$/Barrel 170
160
150
140
100.5
100.0
130
120
99.5
99.0
98.5
110
100
90
98.0
97.5
97.0
80
70
60
Oil price (R)
96.5
96.0
95.5
95.0
2006
2007
2008
2009
2010
2011
2012
2013
2014
50
40
30
20
2015
NBF Economics and Strategy (data via OECD)
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
[email protected]
Paul-André Pinsonnault
Senior Fixed Income Economist
[email protected]
Krishen Rangasamy
Senior Economist
[email protected]
Marc Pinsonneault
Senior Economist
[email protected]
Matthieu Arseneau
Senior Economist
[email protected]
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.