USD: Fading of COVID drag and sizable fiscal stimulus likely to result in very strong GDP/employment growth this year, but we expect the trend in inflation, which will be key to Fed action, to remain low for a while. For now, net weakening in economy remains sizable (lots of slack), and inflation expectations generally remain subdued. Base case is for no tapering until Sep 2022 and no tightening until Sep 2024. The USD needs to blend the ingredients of US exceptionalism and global reflation. While US rates may rise to reflect local growth dynamics, global growth expectations are rising too. Europe will continue to lag the US, but the Fed will likely remain accommodative even after rates adjust for the growth shift. In turn, a mixed USD backdrop, where an expanding business cycle would benefit global risk sentiment.
CAD: The Canadian economy has maintained a strong pace of recovery through the second lockdown. Recent activity data has introduced upside risk to flash estimates for January GDP, and the combination of US stimulus and less drag from lockdowns has pushed expected annual growth for 2021 to 5.7%. The market continues to look for reduced asset purchases from the BoC in April. Expectations of policy divergence has benefited CAD thus far in 2021. Alongside the USD, Canadian growth has outpaced much of the G10 with CAD being the strongest G10 currency behind the USD this year.
EUR: There are growing concerns about Eurozone growth, with a clearer 3rd wave hitting the region, and lockdown conditions needing to tighten again in most large countries. Combined with a disappointingly slow vaccine rollout, the big bounce in EZ GDP growth is unlikely to happen until Q3. Given the relatively less favourable domestic backdrop, the ECB is pushing back against higher rates, and has pledged to increase the pace of PEPP purchases through Q2. A major concern for the EUR right now is that there's not sufficient value to offset the poor growth prospects, negative carry, and weak vaccine rollouts. Equity inflows would be one saving grace but our monthly tracking of portfolio flows should persistent US demand. As a result, while the EUR could rally on any broad USD pullbacks.
GBP: The UK recovery into the spring is looking more assured as the vaccine rollout progresses. The extension of the furlough program into the autumn also pushes back any real rise in the unemployment rate. However, there are still Brexit teething pains to deal with, which we saw with the collapse of trade in the Jan data. We still look for further QE this year though to help boost the recovery and keep yields in check. The GBP remains one of the best- performing G10 currencies YTD on the back of the UK's strong vaccine performance. Supply and distribution issues are starting to arise, however, suggesting other economies may narrow the gap. Higher real rates provide a supportive buffer, but this leaves sterling vulnerable to some profit-taking.
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