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Budget Deficits and the U.S. Dollar

The February announcement by Congress that it would increase government spending this year and next will prompt a temporary growth spurt in the U.S. but have a more permanent impact on America’s budget deficit which is slated to surge past 5% of GDP in the next couple of years. By pushing up Treasury yields near 3%, markets are firing a warning shot about their limited tolerance for fiscal indiscipline. The U.S. dollar is unlikely to flourish in such an environment, even with Fed rate hikes in the cards. As such, we have adjusted our FX targets to show USD weakness persisting for a while longer.

The euro stands to benefit from USD weakness and we have accordingly raised our EURUSD targets. But the path of the common currency over the coming months won’t be linear, with events such as Italy’s March elections expected to periodically fuel volatility.

Concerns about NAFTA, the Canadian housing sector, corporate tax cuts/deregulation in the U.S. are combining to foster a climate of uncertainty on loonie. However, the Canadian dollar has room to appreciate amidst USD weakness which is likely to be reinforced by a sharply deteriorating U.S. budget deficit. The positive economic backdrop for the global economy is also favourable to commodity prices and hence the C$. As such, we have adjusted our targets to show a more resilient loonie over the forecast horizon, albeit with USDCAD remaining in the 1.20-1.30 range for the next 12 months. Those projections, however, assume a favourable outcome to NAFTA negotiations.

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** I have prepared this commentary to give you my thoughts on various investment alternatives and considerations which may be relevant to your portfolio. This commentary reflects my opinions alone, and may not reflect the views of National Bank Financial Group. In expressing these opinions, I bring my best judgment and professional experience from the perspective of someone who surveys a broad range of investments. Therefore, this report should be viewed as a reflection of my informed opinions rather than analyses produced by the Research Department of National Bank Financial **

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