1Q26_ Quarterly Outlook Report_Final_EN - Flipbook - Page 47
T H E P LUMB LI N E | A RETU RN TO F I RS T PRI N CI PL ES
The Canadian dollar (CAD) has failed to rebound in the manner that we expected in 2025. Trade
uncertainties, a recalcitrant Fed and recent bout of market volatility have weighed on sentiment.
We think the Bank of Canada’s (BoC) easing cycle is complete and anticipate some moderate
tightening in policy rate later in 2026 as domestic growth momentum picks up, aided by
supportive fiscal policy. This tightening move will contrast with easier Fed policy in the coming
year. The Fed/BoC policy spread sits at 150bps currently – the widest since the mid-1990s. Our
rate forecasts anticipate that gap closing to 25bps by end-2026. Market-driven yields reflect
some expected compression in the policy spread but have more work to do to reflect our rate
call. A significant narrowing in U.S./Canada yield spreads will be supportive for the CAD.
We are less optimistic on the outlook for the Mexican peso (MXN) despite strong overall
performance in 2025. High domestic yields have supported the MXN globally amid investor
demand for yield. However, we anticipate steady cuts in the Banxico policy rate in 2026 which will
erode the MXN’s appeal, especially if market volatility remains elevated (reducing volatilityadjusted returns). Trade uncertainty remains a factor for the MXN, as well as the CAD.
Among the other major currencies, slightly firmer quarterly growth and a modest pick up in
inflation in 2026 will bolster the outlook for steady European Central Bank (ECB) policy and
underpin the euro (EUR). EURUSD gains have developed largely in line with expectations in recent
months, but we think some additional EUR strength to the 1.22-1.24 range is likely in the medium
term. Domestic politics and focus on fiscal policy have curbed the pound (GBP) and the yen (JPY)
but both remain somewhat undervalued from our perspective. Some modest tightening in the
Bank of Japan (BoJ) policy rate is expected in 2026 which should lift the soft-looking JPY and
while the Bank of England (BoE) is expected to loosen monetary policy a little, the benchmark
rate should remain above the Fed’s, giving the GBP a cushion.
Beyond these considerations, broader market conditions may dictate relative under- and outperformance. If uncertainty and market volatility persist, high beta currencies (commodity,
developing market FX) may perform relatively softly. Heightened focus on fiscal policy or other
policy challenges may favour the handful of currencies (some of them less liquid) that are
structurally better positioned (CHF, SEK, NOK).
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