Forex - January 2022

1 1 Economics and Strategy Forex January 2022 Highlights By St fane Marion/Kyle Dahms The dollar has had an excellent 2021, gaining ground on most major currencies. With the Federal Reserve about to embark on a slightly more aggressive pace of monetary policy normalization than was anticipated a few months ago, some market observers believe the dollar will continue to appreciate. We are not so sure. In our view, with the Fed's net asset purchases about to end by March, we could see a more rapid rise in long-term interest rates. This could substitute for a rise in the federal funds rate and keep the greenback in check. The Canadian dollar has been battered in recent weeks.

2 Even though we expect a slowdown in production in the coming weeks as provinces implement measures to control Omicron, the impact on growth should be relatively short, as this new variant appears to be less virulent than previous ones. Rising commodity prices, a current account surplus, a strong labour market and positive interest rate differentials argue for an appreciation of the Canadian dollar. Across the Atlantic, the common currency has depreciated in the past twelve months. Now, the beginning of 2022 is off to a stumble as the Omicron variant has occasioned closures among several member states. Energy prices have had their fair share of impact on inflation recently and remain elevated compared to a year ago.

3 Overall, we expect the euro to remain relatively tepid in the coming year. NBF Currency OutlookCurrentForward EstimatesPPP (1)CurrencyJanuary 7, 2022Q1 2022Q2 2022Q3 2022Q4 2022 Canadian Dollar(USD / CAD) States Dollar(CAD / USD) Euro(EUR / USD) Yen(USD / JPY)116115115114113103 Australian Dollar(AUD / USD) Sterling(GBP / USD) Yuan(USD / CNY) Peso(USD / MXN) United States Dollar (3) 1) PPP data from OECD, based in Local Currency per USD2) Current Account Balance data from IMF, as a % of GDP (2020 & 2021 IMF estimates)3) Federal Reserve Broad Index (26 currencies)Canadian Dollar Cross CurrenciesCurrentForward EstimatesCurrencyJanuary 7, 2022Q1 2022Q2 2022Q3 2022Q4 2022 Euro(EUR / CAD) Yen(CAD / JPY)9193969392 Australian Dollar(AUD / CAD)

4 Sterling(GBP / CAD) Yuan(CAD / CNY) Peso(CAD / MXN) 2 Economics and Strategy Forex USD: A repeat performance in 2022? The greenback had a great year in 2021, gaining ground on most of the major currencies except for the CNY, the TWD and the CAD (chart). With the Federal Reserve about to embark on slightly more aggressive pace of monetary policy normalization than what was anticipated a few months ago, some market observers believe the dollar could repeat its prior performance. Yet, as we enter the new year, it is worth noting that the broad dollar index has lost from its recent high in October 2021 (chart). We continue to see only three hikes in 2022, slightly less than what is currently expected by the markets.

5 In our view, with Fed net asset purchases on pace to be wrapped up by March, we could see a more rapid increase in long-term interest rates. That could be a substitute to a higher Fed Funds rate. At close to , it is worth noting that the yield on the 10-year note is already back to pre-pandemic levels (chart). Another reason for the Fed to want to limit the number of rate hikes is to prevent the greenback from becoming too strong. According to the BIS, the real effective exchange rate is already quite high by historical standards (chart). This development is not conducive to reducing a trade deficit that currently stands at 4% of GDP (chart). : The greenback trounced most major currencies in 2021 Spot returns for major currencies, YTD to Dec 31 (base = USD)%NBF Economics and Strategy (data via Bloomberg)110112114116118120122124126128 2019Q3 2019Q42020Q12020Q22020Q32020Q42021Q12021 Q22021Q32021Q42022Q1 USD: Weaker to start the yearTrade-weighted USD vs.

6 Broad basket of 26 currencies of advanced and emerging economiesNBF Economics and Strategy (data via Refinitiv) : Long-term interest rates back to pre-pandemic levelsYield on 10-year TreasuriesNBF Economics and Strategy (data via Refinitiv)% : Real effective exchange rate already high dollar real effective exchange rateNBF Economics and Strategy (data via Refinitiv)index 3 Economics and Strategy Forex Last but not least, the Fed has a dual mandate, and as such, it is not only targeting inflation but also employment, which is far from having fully recovered. Payroll employment data has been weaker than expected for two consecutive months and the labor force participation rate for prime aged workers is still very low (chart).

7 CAD: Back to by Q2 2022? The Canadian has been battered in recent weeks. After rising above at the end of December 2021, USD/CAD has fallen back below (chart). We still expect the loonie to appreciate further in the coming months. For one, global manufacturing production continues to expand at a relatively brisk pace (chart). Even though we expect a slowdown in production in the coming weeks as countries implement measures to control Omicron, the impact on growth should be relatively short, as this new variant appears to be less virulent than previous ones. In South Africa, where Omicron was first reported and only 31% of the population is fully vaccinated, the record increase in new cases has not been matched by a similar increase in deaths.

8 The mortality trend is even better in developed economies where a much larger share of the population is vaccinated (chart) : Trade deficit remains well in negative territoryTrade balance as a percentage of GDP (Last data: Q3 2021)% of GDPNBF Economics and Strategy (data via Refinitiv) : Labour market still has room for improvementLabour force participation rate for people aged 25-54%NBF Economics and Strategy (data via Refinitiv) : A roller-coaster exchange rateUSD/CAD NBF Economics and Strategy (data via Refinitiv)384042444648505254565820182019 202020212022 World: Manufacturing sector continued to expand at healthy clipJPMorgan/Markit Global Manufacturing PMI. Last observation: November 2021 Index NBF Economics and Strategy (Source: Markit via Refinitiv)ExpansionContraction 4 Economics and Strategy Forex If this trend continues, we expect consumer spending in the OECD economies to remain relatively strong in 2022 and global industrial production to reach new highs.

9 This means that commodity prices are likely to remain high and possibly rise further. This is good news for Canada. We estimate that the Bank of Canada's commodity price index for 26 commodities produced in our country and sold on world markets reached a new record high early in Q1 2022 when expressed in Canadian dollars (chart). This development should translate in a widening trade surplus, which already stood at a 13-year high of $ billion in November. The surplus with the United States was even more impressive: a staggering $ billion, the largest since 2005 (chart). This sets the stage for a current account balance that is expected to remain in surplus at least until the first half of 2022.

10 Higher commodity prices are not only good for the current account, they also mean higher revenues for businesses. According to Statistics Canada, the Industrial Product Price Index (IPPI), which reflects the price producers receive for their products at the factory gate, rose per cent year-over-year in November (chart). And improving corporate profits generally translates into good job creation. The Canadian labour market ended 2021 with a bang. Including the 55,000 jobs created in December, the labour force grew by 890,000 over the year, with as much as 78% of those gains coming in the private sector. Moreover, most of the new jobs created in 2021 were high paid (chart).