What’s boosting the U.S. dollar—for now

Note: This post was updated on July 27, 2018, to confirm U.S. growth in the second quarter.

Though several factors have conspired to boost the U.S. dollar, the strength isn’t expected to last, CIBC says.

“The U.S. economy continues to reap the benefits of tax reform, which has seen the market buttressing Fed rate hike expectations lately,” says a CIBC monthly foreign exchange report.

U.S. growth topped 4% in Q2, the fastest pace since 2014, and core price inflation is also near target, so “the Fed has every reason to stay on course to higher rates,” says the report.

Protectionism has also contributed to boosting the dollar, the report says.

But easing trade woes in 2019 would likely have the dollar reversing its path. Further, markets will be “looking past the peak impacts of fiscal stimulus next year, and prospects for a slowing U.S. economy in 2019, coupled with the early stages of monetary tightening overseas, will lean towards a softer U.S. dollar,” says the report.

Read: Finding balance amid worldwide QE slowdown

While the U.S. dollar is currently overvalued compared to other currencies, the loonie isn’t one of them, says the report, citing Canada’s balanced position on overall trade with the U.S., and its trade and current account deficit overall.

Still, the Canadian dollar has recently been range-bound, and shows weakness relative to oil. Though markets have recently been pricing in central bank rate hikes after a surge in economic growth, Canada’s growth isn’t expected to last.

“Look for the pace of growth to settle back over the rest of the year as consumption slows, housing market activity remains constrained and trade uncertainties delay capital spending plans,” says the report.

With Fed rate hikes expected at a faster pace than Bank of Canada hikes, CIBC sees USDCAD at $1.34 by year-end, but rebounding to about $1.30 in 2019 (year-end) on U.S.-dollar weakness.

Read: What to expect from the Fed in 2019

“The weakest Canadian dollar levels should come as the threat (but not the actual imposition) of auto tariff heats up,” the report says, forecasting a return to $1.28 in Q2 2019 on signs of progress with NAFTA talks next year.

Currency events to watch

On July 26, CIBC expects the European Central Bank will indicate that its current level of rates will be maintained into mid-2019. However, positive economic data could warrant tightening prior to summer’s end that year, improving the outlook for currency.

“Assuming that trade tensions don’t escalate materially, the euro is still set to see gains against the greenback, breaking well through [€]1.20 in the first half of 2019,” says the report.

On July 31, the Bank of Japan is expected to revise inflation forecasts lower.

“That, along with trade policy uncertainty, should be enough to leave the yen range-bound over the rest of the year,” says the report, with improving fundamentals pushing the yen higher against the U.S. dollar in 2019. Look for USDJPY of ¥104 in Q4 2019.

For more details on currency crosses and the full foreign exchange outlook, read the monthly CIBC report.

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