GLOBAL ECONOMICS & FX STRATEGYFOREIGN EXCHANGE OUTLOOK

Key arguments

• The DXY is in the early stages of a bearish reversal as interest rate differentials erode; market pricing implies just over 40bp of Fed tightening by year-end, which offers downside risk to the USD.
• The Fed is forecast on hold at 3.75% through 2027, but Scotiabank acknowledges low confidence, near-term tightening risk and eventual easing risk, with core PCE running about 3% 3mMA SAAR.
• The Bank of Canada's hawkish hold, removal of neutral guidance and 75bp tightening forecast support USDCAD downside; the bank targets 1.37 in Q4-26 and 1.33 in Q4-27.
• The ECB and BoJ have prepared markets for September rate hikes, the BoE leans toward a move before year-end, and swaps price about 90bp of BoJ tightening through July next year.
• Sentiment and positioning have turned against the USD: risk reversals are back to neutral, reversing March US-Iran tension gains, and CFTC data show significant liquidation of bullish USD bets.
• Structural USD risks persist via large fiscal and current account deficits and crowded global portfolio allocations to USD assets.
• Trade-weighted commodity currencies (AUD, NZD) outperform on hawkish RBA/RBNZ guidance and stronger terms of trade; Latam FX are mixed with MXN resilient, PEN stable and CLP hurt by energy import costs.

Corresponding source evidence

1. Price action in the DXY has largely mirrored the shift in fundamentals with a clear erosion in support offered by interest rate differentials as the outlook for relative central bank policy makes a renewed bearish turn against the USD.
2. Expectations for Fed tightening continue to lean hawkish however the outlook for near - term tightening has faded somewhat with a notable moderation in the pricing of rate hikes this year. · this year
3. Fed Chair Warsh has forcefully defended the central bank ’s commitment to price stability and the pursuit of a 2% inflation target while simultaneously exhibiting a considerable amount of caution in the Fed ’s overall assessment of inflation.