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First Quarter of 2016 EXCHANGE RATE FORECASTS EXCHANGE RATE FORECASTS THE DOLLAR’S APPRECIATION WILL SLOW FURTHER IN 2016 AND 2017 ONCE OIL’S PLUNGE ENDS U.S. Dollar: The Federal Open Market Committee raised the federal funds target range to 0.25 to 0.50 percent at its December 16 meeting, the first U.S. interest rate hike since 2006. In the accompanying monetary policy statement, the Fed affirmed that it expects to make very gradual subsequent rate hikes. PNC Economics forecasts three 25 bps funds rate hikes per year in 2016 and 2017, as the U.S. economy expands moderately and wage growth picks up. As in 2015, resilient consumer spending and domestic demand should continue to offset the drag on growth from weaker manufacturing, exports, and energy. Near-term, the global glut of crude oil increases downside risks to the price of oil. But the sharp drop in U.S. energy exploration – the U.S. oil well rig count fell 65 percent from a year earlier in December 2015 – suggests prices of oil and other commodities are likely to stabilize in 2016 and 2017. If so, the rout of the currencies of commodity-producing economies should also end, slowing the dollar’s appreciation. Australian Dollar: The Australian dollar may have reached a bottom. The Aussie depreciated an average of more than 10 percent for three consecutive years through the end of 2015 as investment in Australian mining peaked and then fell, Chinese demand for Australian commodities weakened, and prices of oil, iron ore, and coal fell. The Aussie dollar’s huge cumulative depreciation is now boosting growth and hiring in Australia’s non-resource sectors: Real GDP grew moderately in the third quarter of 2015, supported by domestic demand and net exports, and the Australian unemployment rate fell in November 2015 to its lowest since March 2014. Following the Aussie dollar’s depreciation to near $0.70 U.S. per Aussie dollar, the Reserve Bank of Australia’s monetary policy statements have become less dovish; if the moderate economic growth of the second half of 2015 continues as expected, the RBA will likely leave its Cash Rate on hold in 2016 at 2.0 percent. A less dovish monetary stance and the possibility of stabilizing commodity prices by 2017 should offset the effect of weaker Chinese growth on the Australian dollar, helping end its long depreciation against the U.S. dollar. 130 125 120 115 U.S. dollar broad index, Jan. 1997 = 100 PNC PNC Forecast 110 105 100 95 90 1.2 U.S. dollars per Australian dollar 1.1 1.0 0.9 0.8 0.7 0.6 PNC Forecast EXCHANGE RATE FORECASTS Brazilian Real: CPI inflation wildly overshot the Central Bank of Brazil’s 2.5-6.5 percent target range in 2015: Consumer electricity tariffs surged as fiscal pressures forced the Brazilian government to cut spending on utility subsidies, and the sharp depreciation of the Brazilian real passed through to higher prices of tradable goods and energy-intensive services like transportation. The Central Bank of Brazil has since July 2015 held its benchmark Selic rate at a highly contractionary 14.25 percent to control inflation and defend its credibility, deepening Brazil’s economic depression. High unemployment and weak domestic demand could ease market-driven inflationary pressures, but political risks are high as Brazil’s public finances erode – President Rousseff fired her fiscally-conservative Finance Minister in December, negative for Brazil’s sovereign creditworthiness. Risks to the Brazilian real continue to be to the downside. Canadian Dollar: The collapse in global oil prices weakened Canadian output in 2015 as expected: The sharp downturn in the capital-intensive mining industry has weakened manufacturing, construction, and capital spending. At the same time, labor market indicators have been resilient: With the weak Canadian dollar pushing Canadian consumers to spend more of their income on domestically-produced goods and services and less on imports, and low energy prices leaving them with more discretionary spending power after filling gas tanks, consumer spending has offset some of the drag from energy. The Canadian dollar’s dramatic depreciation since 2012 has been a product of both its strong correlation with global oil prices and with reduced expectations for Canadian interest rate hikes. If the Bank of Canada hikes its policy rate in the second half of 2016 from its current 0.5 percent to match it to the bottom of the federal funds target range, and if oil prices stabilize as expected, the Loonie may appreciate somewhat in 2016 and 2017. Chinese Yuan: The People’s Bank of China (PBoC) allowed the yuan to resume depreciation against the U.S. dollar after the International Monetary Fund’s November 30 decision to add the yuan to the IMF’s “Special Drawing Right” basket of reserve currencies. Market forces are exerting strong pressure on the yuan to depreciate against the U.S. dollar: Chinese economic growth is weak, Chinese foreign trade is contracting, the PBoC has cut interest rates six times since November 2014, U.S. interest rates are rising, and capital is flowing out of China (As it is flowing out of other emerging markets). Chinese real GDP growth will likely remain below trend in 2016 and 2017, and the industrial core of the Chinese economy will be even weaker than headline GDP statistics would suggest. A trend depreciation of the yuan is one of two important capital market trends to expect from China in 2016 and 2017 – the second is increased spillover of Chinese financial volatility into the country’s exchange rate. China has liberalized capital flows into its highly volatile domestic stock markets. While there are still few linkages between China’s stock market and its domestic economy, limiting the potential for stock market swings to cause a financial crisis, stock market volatility will be a more important catalyst of cross-border capital flows and exchange rate fluctuations in 2016 and 2017 than in years past. 4.50 4.25 4.00 3.75 3.50 3.25 3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.45 1.40 1.35 Brazilian real per U.S. dollar PNC Forecast Canadian dollars per U.S. dollar PNC Forecast 1.30 1.25 1.20 1.15 1.10 1.05 1.00 0.95 7.2 7.1 7.0 6.9 6.8 6.7 6.6 6.5 6.4 6.3 6.2 6.1 6.0 Chinese yuan per U.S. dollar PNC Forecast EXCHANGE RATE FORECASTS Euro: The European Central Bank disappointed global capital markets in December by cutting its deposit rate by “only” 0.1 percentage points to negative 0.3 percent, less than market expectations for a 0.2 percentage point cut. The ECB extended the minimum end date of its asset purchase program to March 2017 from September 2016, but refrained from increasing its monthly rate of purchases. The ECB’s staff economists judge the current amount of monetary stimulus as sufficient to raise CPI inflation back to 1.6 percent by 2017, close to the ECB’s target of “below but close to two percent.” Risks to the Eurozone growth forecast seem fairly balanced: A very competitively valued euro and low energy prices are supporting the Eurozone’s trade competitiveness and domestic demand, creating upside risks to growth, and weak emerging markets and political risks (from both inside and outside of the Eurozone) create downside risks. After spiking stronger against the U.S. dollar after the December ECB decision, the euro will likely depreciate moderately in 2016 and 2017 as ECB monetary stimulus continues at its present pace and U.S. interest rates very gradually rise. Indian Rupee: Unchanged from PNC’s last forecast, India continues to look well-situated to weather higher U.S. interest rates. Economic growth is holding up, with real GDP growth likely to be between 7.0 percent and 7.5 percent in 2016 and 2017. The Reserve Bank of India’s inflation targeting regime is increasing the credibility of Indian economic policy: CPI inflation in the third quarter of 2015 was the lowest since 2004. Low global commodity prices should keep inflation low and growth strong: As a net commodity importer and consumer, low prices of coal, oil, iron ore and other basic materials should contain India’s inflation, shrink its trade deficit, boost consumer spending power, support corporate profit margins, and raise headline real GDP growth. The onset of interest rate hikes in the United States pushed the rupee modestly weaker against the dollar in late 2015, but the longer-term outlook for the rupee still looks stronger than those of other major emerging market currencies. Japanese Yen: The Bank of Japan (BoJ), like the ECB, disappointed capital markets by refraining from expanding its quantitative easing (QE) program at its December monetary policy decision. The BoJ made minor tweaks to its QE program, principally announcing small purchases of Japanese stocks beginning in March 2016 to offset long-planned stock sales. But notably, three of the nine members of the BoJ Policy Board voted against these stock purchases. While low oil prices keep alive the possibility of further easing from the BoJ, December’s split vote on a small-bore expansion in stimulus suggests limited appetite for more aggressive monetary easing. If the BoJ leaves monetary policy unchanged from its current stance in 2016 and the first half of 2017, the divergence between the U.S. and Japanese monetary stances should widen, creating room for some modest additional depreciation of the yen vis-avis the dollar. 1.45 1.40 U.S. dollars per euro 1.35 1.30 1.25 1.20 1.15 1.10 1.05 1.00 72 PNC Forecast Indian rupees per U.S. dollar 68 64 PNC Forecast 60 56 52 48 135 Japanese yen per U.S. dollar 125 115 105 95 85 75 PNC Forecast EXCHANGE RATE FORECASTS Korean Won: The Bank of Korea (BoK) opened 2016 concerned about weak Korean growth and inflation, and determined to pursue an “accommodative” monetary policy; the BoK also lowered its inflation target to 2.0 percent from its previous 2.5-3.5 percent target range. At the same time, the BoK is concerned about potential global financial volatility as U.S. interest rates rise; domestically, financial risks from highly indebted households and financially fragile corporate borrowers are also concerns. The BoK is likely to leave its benchmark base rate on hold at 1.50 percent in 2016 (unchanged since June 2015) and closely monitor the won exchange rate and international capital flows for risks to Korean economic and financial stability. Like the yen, the won is likely to depreciate modestly against the U.S. dollar in 2016 and 2017 as U.S. short-term interest rates rise and Korean monetary policy maintains its accommodative stance. Mexican Peso: The Bank of Mexico (Banxico) followed the Federal Reserve in hiking its benchmark interbank target rate 0.25 percentage points to 3.25 percent on December 17. Banxico spent 2015 signaling loud and clear that Mexican shortterm interest rates are very likely to closely track comparable U.S. benchmarks as the Fed very gradually raises U.S. rates, making the December rate hike nearly a foregone conclusion. Viewed in isolation, Mexico’s domestic economic conditions could justify a looser monetary policy: The oil correction has held growth below trend, obvious slack persists in the labor market, and CPI inflation was near the lowest in half a century during much of 2015. But Mexico’s economy does not exist in isolation. The Bank of Mexico is making the very conservative decision to prioritize financial and exchange rate stability above economic stimulus in 2016 and 2017. Mexico’s hawkish monetary stance, low inflation, close economic ties to the United States, and PNC Economics’ expectation that oil prices recover all make the peso likely to stabilize against the dollar in the second half of 2016 and to appreciate against it in 2017. Pound Sterling: The pound looks likely to stay weaker against the dollar in 2016 and 2017. In December, Bank of England (BoE) Governor Mark Carney talked down expectations for an early 2016 Bank Rate hike, emphasizing that the U.K. is in a “low for long” interest rate environment. Despite the U.K.’s tightening labor market, Carney described the late-2015 decline in global oil prices and depreciation of the yuan as unexpected developments that are likely to exert downward pressure on British inflation, making a rate hike less appropriate. Swap market interest rates in January did not “price in” a BoE rate hike until December 2016. While spillover from quantitative easing in the Eurozone could be holding down British interest rates and making market expectations too dovish, a rate hike before July seems unlikely. The approach of the “Brexit” referendum on the U.K.’s membership in the European Union also seems likely to weigh on the pound. Prime Minister Cameron is pushing to reach a sweetened deal between the U.K. and the European Council in early 2016, but endless Greek-style negotiations are a significant possibility- the Syrian refugee crisis and Paris terrorist attacks bolster British Euroskeptics, limiting Cameron’s room to compromise. 1,250 1,225 Korean won per U.S. dollar 1,200 PNC Forecast 1,175 1,150 1,125 1,100 1,075 1,050 1,025 1,000 18 Mexican pesos per U.S. dollar 17 16 PNC Forecast 15 14 13 12 1.75 U.S. dollars per U.K. pound sterling 1.70 1.65 1.60 1.55 1.50 1.45 PNC Forecast EXCHANGE RATE FORECASTS Baseline Currency Forecast Table, First Quarter of 2016 Australia Brazil Canada China Australian $ Real Canadian $ Yuan Eurozone Euro USD per AUD BRL per USD CAD per USD CNY per USD USD per EUR Dec-2011 1.02 1.88 1.02 6.29 1.29 Dec-2012 1.04 2.04 0.99 6.23 1.32 Dec-2013 0.89 2.34 1.06 6.05 1.38 Dec-2014 0.82 2.66 1.16 6.21 1.21 Jun-2015 0.77 3.10 1.25 6.20 1.12 Dec-2015 0.73 3.90 1.38 6.49 1.09 Jun-2016 0.72 4.10 1.38 6.70 1.07 Dec-2016 0.72 4.20 1.37 6.90 1.06 Jun-2017 0.73 4.30 1.36 7.00 1.05 Dec-2017 0.74 4.40 1.35 7.10 1.05 United Kingdom India Japan Korea Mexico U.S. Broad Pound Sterling Rupee Yen Won Peso Dollar Index USD per GBP INR per USD JPY per USD KRW per USD MXN per USD Jan '97 = 100 Dec-2011 1.55 53.3 77.6 1,152 14.0 100.6 Dec-2012 1.62 54.8 86.3 1,071 13.0 99.2 Dec-2013 1.65 61.9 105.4 1,055 13.1 101.9 Dec-2014 1.56 63.3 119.8 1,099 14.8 111.3 Jun-2015 1.57 63.8 122.3 1,116 15.7 115.5 Dec-2015 1.48 66.3 120.4 1,173 17.2 123.0 Actual (month-end) PNC Forecast Actual (month-end) PNC Forecast Jun-2016 1.48 66.0 123.0 1,190 17.0 124.1 Dec-2016 1.49 65.0 125.0 1,200 16.8 125.2 Jun-2017 1.50 64.5 126.0 1,210 16.7 125.8 Dec-2017 1.50 64.0 127.0 1,220 16.6 126.2 Table and chart sources: Reserve Bank of Australia, Bank of Canada, China Foreign Exchange Trading Center, Banco Central do Brasil, Bank of Japan, European Central Bank, Reserve Bank of India, Bank of Korea, Bank of England, CEIC, The PNC Financial Services Group Visit http://www.pnc.com/economicreports to view the full listing of economic reports published by PNC’s economists. Disclaimer: The material presented is of a general nature and does not constitute the provision of investment or economic advice to any person, or a recommendation to buy or sell any security or adopt any investment strategy. Opinions and forecasts expressed herein are subject to change without notice. Relevant information was obtained from sources deemed reliable. Such information is not guaranteed as to its accuracy. You should seek the advice of an investment professional to tailor a financial plan to your particular needs. © 2016 The PNC Financial Services Group, Inc. All rights reserved.