Currencies

HighlightsThe power shortage in China due to depleted coal inventories and low hydro availability will push copper and aluminum inventories lower, as refineries there – which account for roughly one-half of global capacity – are shut to conserve power (Chart of the Week).Given the critical role base metals will play in the decarbonization of the global economy, alternative capacity will have to be incentivized ex-China by higher prices to reduce refining-concentration risk in the future.Unexpectedly low renewable-energy output in the EU and UK following last year's cold winter will keep competition with China for LNG cargoes elevated this winter.  It also highlights the unintended consequences of phasing down fossil-fuel generation without sufficient back-up.The US Climate Prediction Center kept its expectation for a La Niña at 70-80%, which raises the odds of a colder-than-normal winter for the Northern Hemisphere.  Normal-to-warmer temps cannot be entirely dismissed, however.Increased production of highly efficacious COVID-19 vaccines globally – particularly in EM economies – will stoke economic growth and release pent-up demand among consumers.We remain long 1Q22 natgas exposure via call spreads; long commodity index exposure (S&P GSCI and COMT ETF) to benefit from increasing backwardation as inventories of industrial commodities fall; and long the PICK ETF to benefit from expected tightening of base metals markets.FeatureNatgas prices are surging in the wake of China's and Europe's scramble to cover power shortages arising from depleted coal inventories and low hydroelectric generation in the former, and unexpectedly low output from renewables in the latter (Chart 2).1Given all the excitement of record-high gas prices in the EU and surging oil prices earlier this week, it is easy to lose sight of the longer-term implications of these developments for the global decarbonization push. Chart of the WeekBase Metals Refining Concentrated In China  Chart 2Surge In Gas Prices Continues Global copper inventories have been tightening (Chart 3) along with aluminum balances (Chart 4).2 Power shortages in China- which accounts for ~40% of global refined copper output and more than 50% of refined aluminum - are forcing shutdowns in production by authorities seeking to conserve energy going into winter. In addition, the upcoming Winter Olympics in February likely will keep restrictions on steel mills, base-metals refiners, and smelters in place, so as to keep pollution levels down and skies blue. Chart 3Supply-Demand Balance Tightening In Copper  Chart 4Along With Aluminum Balances... This will keep prices well supported and force manufacturers to draw on inventories, which will keep forward curves for copper (Chart 5) and aluminum (Chart 6) backwardated. Higher costs for manufactured goods can be expected as well, which will exacerbate the cost-push inflation coming through from clogged global supply chains. This slowdown in global supply chains is largely the result of global aggregate demand improving at a faster rate than supply.3 Chart 5Copper Prices And Backwardation  Chart 6...Will Increase Along With Aluminum The pressures on base metals markets highlight the supply-concentration risks associated with the large share of global refining capacity located in China. This makes refined base metals supplies and inventories globally subject to whatever dislocations are impacting China at any point in time. As the world embarks on an unprecedented decarbonization effort, this concentration of metals refining capacity becomes increasingly important, given the centrality of base metals in the build-out of renewable-energy and electric-vehicles (EVs) globally (Chart 7).In addition, increasing tension between Western states and China supports arguments to diversify supplies of refined metals in the future (e.g., the US, UK and Australia deal to supply US nuclear-powered submarine technology to Australia, and the tense Sino-Australian trade relationship that led to lower Chinese coal inventories).4 Chart 7The Need For Refined Metals Grows EU's Renewables Bet SoursUnlike China, which gets ~ 11% of its electricity from renewables and ~ 63% of its power from coal-fired generation (Chart 8), the EU gets ~ 26% of its power from renewables and ~ 13% from coal (Chart 9). In fact, the EU's made a huge bet on renewables, particularly wind power, which accounts for ~55% of its renewables supply. Chart 8China's Dependence On Coal …  Chart 9… Greatly Exceeds The EU's Unexpectedly low renewable-energy output in the EU and UK this summer – particularly wind power – forced both to scramble for natgas and coal supplies to cover power needs.5 As can be seen in Chart 9, the EU has been winding down its fossil-fuel-fired electric generation in favor of renewables. When the wind stopped blowing this year the EU was forced into an intense competition with China for LNG cargoes in order to provide power and rebuild storage for the coming winter (Chart 10). Chart 10The Scramble For Natgas Continues The current heated – no pun intended – competition for natgas going into the coming winter is the result of two policy errors, which will be corrected by Spring of next year. On China's side, coal inventories were allowed to run down due to diplomacy, which left inventories short going into winter. In the EU, wind power availability fell far short of expectations, another result of a policy miscalculation: Nameplate wind capacity is meaningless if the wind stops blowing. Likewise for sun on a cloudy day.Natgas Price Run-Up Is TransitoryThe run-up in natgas prices occasioned by China's and the EU's scramble for supplies is transitory. Still, uncertainty as to the ultimate path global gas prices will take is at its maximum level at present.The US Climate Prediction Center kept its expectation for a La Niña at 70-80%, which raises the odds of a colder-than-normal winter for the Northern Hemisphere. Even so, this is a probabilistic assessment: Normal-to-warmer temps cannot be dismissed, given this probability. A normal to warmer winter would leave US inventories and the availability to increase LNG exports higher, which would alleviate much of the pricing pressure holding Asian and European gas prices at eye-watering levels presently.Going into 1Q22, we expect increased production of highly efficacious COVID-19 vaccines globally – particularly in EM economies – will stoke economic growth and release pent-up demand among consumers as hospitalization and death rates continue to fall (Chart 11).6 At that point, we would expect economic activity to pick up significantly, which would be bullish for natgas. We also expect US and Russian natgas production to pick up, with higher prices supporting higher rig counts in the US in particular. Chart 11Expect Continued COVID-19 Progress Investment ImplicationsAs the world embarks on an unprecedented decarbonization effort, it is important to follow the supply dynamics of base metals, which will provide the materials needed to build out renewable generation and EVs.The current price pressure in natural gas markets resulting from policy miscalculations cannot be ignored. Still, this pressure is more likely to be addressed quickly and effectively than the structural constraints in base metals markets.On the base metals side, producers remain leery of committing to large capex projects at the scale implied by policy projections for the renewables buildout.7In addition, current market conditions highlight concentration risks in these markets – particularly on the refining side in base metals, where much of global capacity resides in China. On the production and refining side of EV materials, battery technology remains massively concentrated to a few countries (e.g., cobalt mining and refining in the Democratic Republic of Congo and China, respectively).This reinforces our view that oil and gas production and consumption likely will not decay sharply unless and until these capex issues and concentration risks are addressed. For this reason, we remain bullish oil and gas. Robert P. Ryan Chief Commodity & Energy Strategistrryan@bcaresearch.comAshwin ShyamResearch AssociateCommodity & Energy Strategyashwin.shyam@bcaresearch.com Commodities Round-UpEnergy: BullishDelegates at OPEC 2.0's Ministerial Meeting on Monday likely will agree to increase the amount of oil being returned to markets by an additional 100-200k b/d. This would take the monthly production rate of production being restored from 400k b/d to 500-600k b/d. Depending on how quickly mRNA vaccine production in large EM markets is rolled out, this incremental increase could remain in place into 2Q22. This would assuage market concerns prices could get to the point that demand is destroyed just as economic re-opening is beginning in EM economies. Our view remains that the producer coalition led by Saudi Arabia and Russia will continue to balance the need for higher revenues of member states with the fragile recovery in EM economies. We continue to expect prices in 2022 to average $75/bbl and $80/bbl in 2023 (Chart 12). This allows OPEC 2.0 states to rebuild their balance sheets and fund their efforts to diversify their economies without triggering demand destruction.Base Metals: BullishA power crunch and decarbonization policies in China are supporting aluminum prices at around 13-year highs, after reaching a multi-year peak earlier this month (Chart 13). The energy-intensive electrolytic process of converting alumina to metal makes aluminum production highly sensitive to fluctuations in power prices. High power prices and electricity shortages are impacting aluminum companies all over China, one of which is Yunnan Aluminium. According to the Financial Times, the company accounts for 10% of total aluminum supply in the world’s largest producer.Precious Metals: BullishGold prices dipped following a hawkish FOMC meeting last week. More Fed officials see a rate hike in 2022, compared to the previous set of projections released in June. Fed Chair Jay Powell also hinted at a taper in the asset purchase program on the back of a rebounding US economy, provided a resurgence in COVID-19 does not interrupt this progress. A confirmation of what markets were expecting – i.e., paring asset purchases by year-end – and possible rate hikes next year have buoyed the US dollar and Treasury yields. The USD competes directly with gold for safe-haven investment demand. Higher interest rates will increase the opportunity cost of holding the yellow metal. As a result, gold prices will be subdued when the USD is strengthening. We remain bearish the USD, and, therefore, bullish gold. Chart 12Oil Forecasts Hold Steady  Chart 12Aluminum Prices Recovering   Footnotes1     Please see China's Yunnan imposes output curbs on aluminium, steel, cement makers published by reuters.com on September 13, 2021.2     NB: Global aluminum inventory data are unreliable and we do not publish them.3    Please see, e.g., Supply Chains, Global Growth, and Inflation, published by gspublishing.com on September 20, 2021.4    Please see US-China: War Preparation Pushes Commodity Demand, a Special Report we published on August 26, 2021, for further discussion.5    We discuss this in last week's report entitled Natgas Markets Continue To Tighten, which is available at ces.bcaresearch.com.6    Please see Upside Price Risk Rises For Crude, which updated our oil-price balances and forecasts. We highlight the recent agreements to mass produce the highly effective mRNA COVID-19 vaccines globally as bullish for oil prices. It also will be bullish for natgas and other commodities.7     Please see Assessing Risks To Our Commodity Views, which we published on July 8, 2021, for additional discussion. Investment Views and ThemesStrategic RecommendationsTactical TradesCommodity Prices and Plays Reference TableTrades Closed in 2021Summary of Closed Trades

Highlights The current burst of inflation in developed economies is due to a (negative) supply shock rather than a (positive) demand shock. Consumer complaints of “poor buying conditions” mean that higher prices will cause demand destruction. Hence, it is extremely dangerous for central banks to respond with the signalling of tighter policy that leads to higher bond yields. The upper limit to the 10-year T-bond yield is no higher than 1.8 percent. Hence, this yield level would be a good cyclical entry point into both stocks and bonds. Continue to underweight consumer discretionary versus the market, given the very tight connection between weaker spending on durables and the underperformance of the goods dominated consumer discretionary sector. Commodities whose prices have not yet corrected are at much greater risk than those whose prices have corrected. Hence a new cyclical recommendation is to go underweight tin versus iron ore. Fractal analysis: Netflix versus Activision Blizzard, and AUD/NZD. Feature Chart of the Week"Buying Conditions Are Poor" The current burst of inflation in developed economies is due to a (negative) supply shock rather than a (positive) demand shock. Getting this diagnosis right is crucial, because responding to supply shock generated inflation with tighter monetary policy is extremely dangerous. Responding to supply shock generated inflation with tighter monetary policy is extremely dangerous. The current burst of inflation cannot be due to a demand shock. If it was, aggregate demand would be surging. But it is not. For example, in the US, both consumer spending and income lie precisely on their pre-pandemic trend (Chart I-2). Furthermore, consumers are complaining that high prices for household durables, homes, and cars have caused “the poorest buying conditions in decades”, according to the University of Michigan’s latest consumer sentiment survey. If a positive demand shock was boosting incomes relative to prices, consumers would not be making this complaint. Given that they are making this complaint, there is the real risk of demand destruction. Meanwhile, employment remains far below its pre-pandemic trend. For example, in the US, by about 8 million jobs (Chart I-3). How can demand be on trend, but employment so far below trend? As an economic identity, the answer is that productivity has surged. Yet this should come as no surprise, because after recessions, productivity always surges. Chart I-2Demand Is On Trend... Chart I-3...But Employment Is Well Below Trend After Recessions, Productivity Always Surges As we explained in What The Olympics Teaches Us About Productivity Growth, productivity growth comes from better biology (which improves both our physical and intellectual capacity), better technology, and finding better ways to do the same thing. Of these three drivers, the first two are continuous processes but the third, finding better ways to do the same thing, is a step function whose up-steps come after disruptive changes in the economy such as recessions (Chart I-4). Chart I-4After Recessions, Productivity Always Surges To do things better, a recession is the necessary catalyst for the wholesale adoption of an existing technology. For example, the mass manufacturing of autos already existed well before the Great Depression, but the Depression catalysed its wholesale adoption. Likewise, word processors existed well before the dot com bust, but the 2000 recession finally killed the office typing pool. In the same way, the technology for remote meetings and online shopping has been around for years, but the pandemic has catalysed its wholesale adoption. Of course, it is sub-optimal to meet people remotely or shop online all the time. But it is also sub-optimal to do these things in-person all the time. The most productive way is some hybrid of remote and in-person, which will differ for each person. The pandemic has given us the opportunity to find this personally optimal hybrid, and thereby to boost our productivity. The current boost to productivity could be larger than those after previous recessions because the pandemic has reshaped the entire economy. The current boost to productivity could be larger than those after previous recessions because the pandemic has forced us all to challenge our best practices. This is different from previous post-recession periods where transformations were focussed in one sector. For example, the 80s recession reshaped manufacturing, the dot com bust changed the technology sector, and the 2008 recession transformed the financial sector. By comparison, the current transformation is reshaping the entire economy. Yet, if productivity is booming, why has inflation spiked? The answer is that we have experienced a massive and unprecedented (negative) supply shock. It’s A Supply Shock, Not A Demand Shock To repeat, there has been no positive shock in aggregate demand. Yet there has been a massive shock in the distribution of this demand. Pandemic restrictions on socialising, interacting, and movement meant that leisure, hospitality, in-person shopping, and travel services were unavailable. As spending on services slumped, consumers shifted their firepower to items that could be enjoyed within the pandemic’s confines; namely, durable goods (Chart I-5). Chart I-5A Massive Displacement In The Distribution Of Demand Led To Supply Shocks The problem is that modern supply chains have few, if any, built-in redundancies. They are always working ‘just in time’ and cannot cope with any surge in demand. To make matters worse, the type of goods in high demand also shifted: for example, from electronic goods during full lockdown – to cars when lockdowns eased, and people required local mobility. These shifting spikes in demand stressed and indeed snapped fragile supply chains, resulting in skyrocketing prices for durables. To assess the contribution to overall inflation, we need to gauge the deviation from the pre-pandemic trend. Relative to where they would have been, prices are higher by 0.5 percent for services, 1 percent for non- durables, but by a staggering 10 percent for durables. It follows that most of the current burst of inflation is due to the supply shock for durables (Chart of the Week). But now, consumer complaints that “buying conditions are poor” imply that high prices risk demand destruction as people wait for better conditions (lower prices) to make non-essential purchases. In any case, as we learn to live with the pandemic, the shock in the distribution of demand is easing. Meaning that the abnormally high spending on durable goods has a long way to fall. Furthermore, supply bottlenecks always clear as output responds with a lag. This risks unleashing a flood of supply just as higher prices have destroyed demand. Add to this mix a slowdown, or worse a slump, in China’s real estate and construction sector as we highlighted last week in The Real Risk Is Real Estate (Part 2). And the irony is that, for many global sectors, there could be a demand shock after all but it would be a negative demand shock. Three Investment Recommendations As consumers’ current complaints of poor buying conditions testify, the higher prices that come from a supply shock eventually lead to demand destruction. Hence, it is extremely dangerous for central banks to respond with tighter policy, including the signalling of tighter policy that leads to higher bond yields. The higher bond yields will, with a lag, choke demand just as the supply bottlenecks ease and unleash a flood of supply. Resulting in a deflationary shock for the economy, stock market, and commodities (Chart I-6). Chart I-6When Supply Shocks Ease, Prices Slump On this basis, we are making three investment recommendations: The upper limit to the 10-year T-bond is no higher than 1.8 percent, as we detailed in Stocks, Not The Economy, Will Set The Upper Limit To Bond Yields. Hence, this yield level would be a good cyclical entry point into both stocks and bonds. Continue to underweight consumer discretionary plays versus the market, given the very tight connection between spending on durables and the relative performance of the goods dominated consumer discretionary plays in the stock market. As supply shocks always ultimately ease, those commodities whose prices have not yet corrected are at much greater risk than those commodities whose prices have corrected. Specifically, the price of industrial metals such as tin are at their most stretched versus iron ore in a decade (Chart I-7). Moreover, this fragility is confirmed by fractal analysis (Chart I-8 and Chart I-9). Chart I-7Tin Is Very Stretched Versus Iron Ore Chart I-8Tin Is Fragile Chart I-9Tin Versus Iron Ore Is Fragile Hence, as a new cyclical recommendation, go underweight tin versus iron ore. Netflix Versus Activision Blizzard, And AUD/NZD Are Susceptible To Reversal In pure entertainment plays, the strong outperformance of Netflix versus Activision Blizzard has been fuelled by the delta wave of the virus, which helped Netflix, combined with the Chinese crackdown on gaming companies, which weighed down the whole gaming sector including Activision. The gaming company was also hit by a discrimination lawsuit, which it has now settled. Fractal analysis suggests that this strong outperformance is now fragile. Accordingly, the recommended trade is to short Netflix versus Activision Blizzard, setting a profit target and symmetrical stop-loss at 10 percent (Chart I-10). Chart I-10Netflix Versus Activision Blizzard Is Susceptible To Reversal Meanwhile, in foreign exchange, the recent sell-off in AUD/NZD has reached fragility on the 130-day dimension which has reliably signalled previous reversal points (Chart I-11). Hence, the recommended trade is long AUD/NZD, setting a profit target and symmetrical stop-loss at 2 percent. Chart I-11AUD/NZD Is Likely To Rebound   Dhaval Joshi Chief Strategist dhaval@bcaresearch.com Fractal Trading System Fractal Trades 6-Month Recommendations Structural And Thematic Recommendations Closed Fractal Trades   Indicators To Watch - Bond Yields Chart II-1Indicators To Watch - Bond Yields ##br##- Euro Area Chart II-2Indicators To Watch - Bond Yields ##br##- Europe Ex Euro Area Chart II-3Indicators To Watch - Bond Yields ##br##- Asia Chart II-4Indicators To Watch - Bond Yields ##br##- Other Developed   Indicators To Watch - Interest Rate Expectations Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations  

Dear client, There will be no weekly bulletin next week. Instead, I will be hosting a webcast, with my colleague, Matt Gertken, titled “Currencies And Geopolitics: A Discussion.” I hope you will tune in so that we can have an interactive session. Also, we will be revamping the traditional backsections that FX has been publishing and will send a mockup in the coming weeks. Feedback on the new format will be greatly appreciated. Finally, I hosted a webcast this week with Japanese clients titled “A Guide To Currency Management For Japanese Corporates.” For those who are interested but were unable to attend, I encourage you to consult your sales representative for a replay. Kind regards, Chester Highlights The Fed will taper asset purchases this year, but it could be a non-event for the US dollar. The reason is that the Fed is lagging other G10 central banks in tapering asset purchases. Many will end QE even before the Fed begins tapering. The two big exceptions are the ECB and the BoJ. But while dovish monetary policy is well priced into both the interest rate curve and their currencies, upside surprises are not. Most global central banks will remain data dependent. So the key to gauging the move in currencies is to observe (and forecast) economic data. On that front, the current evidence is that US growth is robust, but is losing momentum to other developed markets. Volatility in currencies will be on the rise. We went long CHF/NZD on this basis last week and maintain long yen positions. But our bias is that any rally in the DXY will fizzle out at the 94-95 level. Feature This week was a busy one for central bankers. We kicked off with the Riksbank on Tuesday, the Bank of Japan and the Federal Reserve on Wednesday, and concluded with the Swiss National Bank, the Bank of England, and the Norges bank on Thursday. The highlight was the Fed, but the general message from most central banks is that less monetary accommodation will be forthcoming, as economic activity picks up. Most central bankers also admitted that inflation was proving a bit more sticky than initially anticipated. The key question therefore for currency strategists is whether the Federal Reserve will be more or less orthodox with monetary policy, compared to other developed market central banks, and what that means for the dollar. Our bias is that while the Fed was slightly more hawkish this week, it will continue to lag other G10 central banks in curtailing monetary accommodation. The Message From The FOMC Chart I-1The Market Has Priced Fed Hawkishness The key development from the Fed meeting this week was an upgrade to the dot plot. Half of the committee now expects at least one interest rate hike in 2022, with perhaps 7-8 hikes by the end of 2024. This is a more aggressive path of interest rate increases compared to the June FOMC meeting. The Fed also suggested tapering could begin at the next policy meeting and end towards the middle of next year, in time for rate increases. The immediate market response to the FOMC meeting did certainly suggest a hawkish undertone. The two-year US Treasury yield rose by 4 bps, which boosted the DXY index from a low of 93 to a high of 93.5 (intraday). Stocks rose and the 10-year Treasury yield edged mildly lower. The 30/2-year Treasury slope flattened by almost 10 bps. In our view, this was a rather muted response. For one, most of these moves are fading as we go to press. More importantly, going into the meeting, the market was already priced for a liftoff in 2022. This will suggest that the market was well positioned for Fed tapering at a minimum, and possibly an upgrade to the dots (Chart I-1). The Message From Other Central Banks While the Fed is still considering tapering asset purchases (and would very likely do so) by year-end, other central banks are well ahead in exiting emergency monetary settings. Just this week: The Norges bank hiked interest rates by 25 bps. We are particularly bullish on the krone, as highlighted in our Norwegian Method report; The Riskbank will end asset purchases this year. Its balance sheet is slated to be flat for 2022. It also closed all lending facilities launched during the pandemic. The offer for USD loans via the Fed’s swap facility will expire this month; The Bank of England kept monetary policy unchanged, but has already purchased £852bn of its £895bn target for government and corporate bonds. In fact, two of its members voted this week to reduce this target by £35bn, which would have effectively ended QE on a majority vote; The Swiss National Bank said in its introductory statement that it is fighting against an expensive franc, but modestly upgraded its inflation forecasts for 2022; The sole dovish central bank (aside from the SNB) was the Bank of Japan, but with elections on the horizon, and the possibility (or not) of a big fiscal package, their policy stance made sense.  Chart I-2Central Bank Holdings Of Government Bonds Elsewhere, the Bank of Canada has already cut its asset purchases in half, the Reserve Bank of New Zealand has ended QE, and the Reserve Bank of Australia has already been tapering asset purchases. In a nutshell, a Fed tapering at this point is well behind the actions of other G10 central banks. This is one key reason why the DXY index has failed to punch above the 94-95 level, and is relapsing as we go to press. From a bird’s eye view, many G10 central banks already have bloated balance sheets and a strong incentive to curtail asset purchases as growth recovers. Within the G10, the US central bank has the smallest holdings of outstanding bonds (Chart I-2). This not only means that, ceteris paribus, the incentive to taper asset purchases is bigger for other central banks, but the scope for the Federal Reserve to ease monetary policy is quite substantial should another shock occur. This might explain why there is unease among other central bankers, to exit emergency settings. Admittedly, this week, traditionally dovish central banks such as the Bank of Japan and the Swiss National Bank kept policy on hold and telegraphed a message that they will keep doing so for the foreseeable future. With a slightly more hawkish Federal Reserve, this should be a negative for these currencies. The same will apply to the ECB (Chart I-3). However, it is important to note that relatively dovish policy settings are well priced into both interest rate curves and their currencies, while upside surprises are not. The market does not expect any interest rate increases in the euro area or Japan before 2024, while it is priced for an aggressive pace of Fed rate hikes (Chart I-4). The starting point for any currency investor is an extremely dovish ECB and BoJ, relative to the Fed. Chart I-3A Pickup In US Yields Has Boosted The Dollar Chart I-4Markets Expect A More Aggressive Fed What Could Change? Global central banks are clearly focused on two goals – the outlook for growth and what that means for their maximum employment objective, and the long-run rate of inflation. These two objectives are interlinked. On the growth front, central bankers are justifiably admitting that the outlook remains clouded due to the Delta variant of COVID-19 and supply disruptions that are muddling the manufacturing outlook. However, it is important to remember that this is a global phenomenon. On a relative basis, there has been a growth rotation from the US to other economies that has historically supported the performance of DM currencies (Chart I-5). The primary reason is that many economies outside the US were in various forms of a lockdown over the last several months. As these economies reopen, so will economic activity. Chart I-5ARelative Growth And Currencies Chart I-5BRelative Growth And Currencies On the inflation front, the most acute problem has been tied to supply bottlenecks and this is not a US-centric problem. Inflation in the euro area, Sweden, the UK, Canada, or New Zealand are all above central bank targets (Table I-1). While all these central banks view the current overshoot as temporary, most have already pared back emergency monetary settings, as we highlighted above. Table I-1Inflation In The G10 The key takeaway is that most central banks view inflation risks as symmetric, while the Fed has telegraphed it is willing to tolerate an inflation overshoot following downturns (Chart I-6). During the Fed’s last two meetings, it has been clear that there is a limit to how much of an overshoot they will tolerate. However, it still suggests that the Fed remains well behind the inflation curve, with one of the most negative 2-year rates in the G10 (Chart I-7). Chart I-6The Fed And Inflation Overshoots Chart I-7Real Yields In The US Are Very Low In a nutshell, if our bias turns out to be correct that growth does recover more earnestly outside the US, and other central banks remain more orthodox than the Fed, this will be a headwind for a stronger US dollar. A Final Note On Canada Canada re-elected a Liberal minority government on September 20. Prime Minister Justin Trudeau’s bet on a majority government, given an astute handling of the pandemic, and massive fiscal stimulus, failed. The implication is a continuation of the status quo in Canada. The good news is that the status quo is actually bullish for the loonie. As we highlighted in our recent report, minority governments tend to be positive for the loonie, while majority governments generally nudge the CAD lower post election (Chart I-8). The rationale is that fiscal policy is slated to stay easy, but not overly so, providing gentle room for the BoC to hike interest rates. Easy fiscal but tighter monetary policy is usually bullish for a currency. Chart I-8Historically, The CAD Likes A Minority Government Given our view on the US dollar, we expect the CAD/USD to punch above the recent 82-cent high, towards 85 and eventually 90 cents. While this view might take time to play out, both rising relative interest rates in Canada (our base case) and high oil prices will be the key catalysts. Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Trades & Forecasts Forecast Summary Strategtic View Cyclical Holdings (6-18 months) Tactical Holdings (0-6 months) Limit Orders Closed Trades