George Davis:
Welcome to the July edition of the George Davis Report. We're actually recording a little bit earlier than usual, number one to get to you before you head off for your summer holidays, but more importantly, number two, because we wanted to highlight some important changes that we've made to our Canadian dollar forecasts. So just to set the background up a little bit, not much has changed in terms of our expectations in Canada.
In terms of economic growth, RBC Economics continues to expect somewhat weak growth of just 0.6% this year in 2026, and that's coming down from 1.9% in 2025. And our rate strategists continue to expect the Bank of Canada to keep interest rates on hold for the balance of this year. And that view hasn't really changed since the beginning of the year. So again, no major changes on the Canadian side of the equation.
However, where we've seen a lot of change is on the US side and that's caused us to reassess our broader outlook for the US dollar and that's impacted our forecasts for dollar Canada as well. And essentially what's happened is a lot of the potential bearish scenarios for the US dollar have started to fade and there's four or five important points to make around that.
Number one, in terms of capital flows, we continue to see capital flow into US investments. And if you look back to the beginning of 2025, there's only essentially been two months of negative flows or outflows from US investments. One of those months being April of last year when we got the so-called Liberation Day tariffs and that generated a lot of uncertainty in terms of how investors were going to respond to that.
But by and large, since then we've continued to see positive flows into US assets, especially since the overarching theme in terms of investments has been AI, and the US is at the forefront in terms of developments in AI. There's been huge demand for capital to finance that theme as well. And so essentially that's put a little bit of a floor under the US dollar. So that's one development of note.
The second thing is that since the beginning of the Iran conflict, what we've seen is a little bit of a shift in terms of how investors have perceived the US dollar. Since the second half of 2024, investors generally viewed the US dollar as being somewhat risk neutral as a currency. But since the onset of the Iran conflict, essentially what we've seen is investors have shifted and pivoted and have viewed the US dollar more as a safe haven type of asset. And given the uncertainty around the war, again, that has helped to put a floor under the US dollar. So that's a second factor that's come into play.
And then thirdly is carrying costs and hedging costs. And if we look at the G10 currencies, one of the things that's interesting right now is that US yields are higher than six of the nine currencies in that G10 basket. So rate differentials have been favoring the US dollar and that's been encouraging some of those investment inflows as well. And as a byproduct of that, what that does is it creates higher hedging costs for foreign investors that are holding those US assets. And so that serves as a bit of a deterrent to sell US dollars as a hedge. And so that's another theme that's become a lot more significant of late.
And then lastly, more recently, we've seen a significant repricing in Fed interest rate expectations. If you go back to March of this year, the market was basically pricing in two rate cuts from the Fed. And if you fast-forward to where we are currently right now, the market has shifted quite dramatically and they're actually now pricing in roughly one and a half hikes. And so that's been a significant shift that's caused a further widening in rate differentials in favor of the US and that's really what's helped to boost the US dollar more recently over the past month or so.
And in particular, when we look at dollar Canada, we've had some pretty important topside breakouts above the 1.3930 area and then more recently 1.4150. And so as part of that broader backdrop, what's happened is inflation levels being firmer in the US with growth levels remaining firm in the US. Our US economics team has basically removed the two rate cuts that they had in their forecast profile. And so when we put all of that together, that's really caused us to reassess our broader outlook for the US dollar and for dollar Canada in particular.
And the removal of those expected rate cuts in the US and the market repricing of Fed expectations has caused us to raise our profile for the US dollar as we looked at our forecasts. So in terms of dollar Canada and our forecast right now, we think the risk is tilted towards more strength in dollar Canada going into year-end where we have 1.4500 as our new year-end forecast, so much higher than what we had previously. And at that point we do expect to see a little bit of a peak as we go into Q1 of next year and through the balance of next year, we see dollar Canada starting to come off again.
And that's with the expectation that next year we start to see the Bank of Canada raise interest rates while the Fed remains on hold and that will cause a narrowing in rate differentials and it'll also cheapen up hedging costs, and that could potentially generate a little bit more downside for the US dollar. So it's a very important shift to take note of, especially for those clients that are sellers of US dollars to hedge their exposure. We're entering into what we would call a "window of opportunity" right now.
And if we look at some important resistance levels, we have some resistance coming in around the 1.4300 level and then above there, 1.4415. So I think those are a couple of levels to keep in mind if you're a seller of US dollars. And then on the downside in terms of important support, what we would have to see going forward is prices break back below the 1.4000 area to suggest that the current uptrend in dollar Canada is starting to lose some momentum.
So again, if you're a US dollar seller, if we start to break below the 1.4000 level, I think that's potentially where you might want to have some stop losses in the market to prevent the market running away from you and allowing you to at least participate in this move higher because just at the beginning of May, we were down at 1.3550 and we've gone up towards 1.4200 in a very, very short period of time. So you want to be able to still benefit from that. And if you're a US dollar buyer, we'll have to see a break back below that 1.4000 level to start to turn things a little bit more positive.
Now in terms of our expected trading range, given our forecast revisions, we're going to bump that up. We're going to go 1.3900 on the downside and 1.4400 on the top side for the month ahead. Now stay tuned for our next update in early August where we'll reassess the economic backdrop and see if that necessitates any changes to our outlook.