The Fed is in the process of raising policy rates at the fastest pace since the seventies. Since March, we have increased rates by two and a quarter percentage points. The U.S. central bank has also started to roll back extensive asset purchases—bond purchases. One of the key questions that investors in fixed income have now is, have we already seen the peak in U.S. yields at three and a half percent earlier this year?

It's closely related to the question about, have we already seen the peak in inflation? There are two competing views on how the inflation story unfolds. It boils down to the pace of inflation declines. One camp, which is aligned with the current market pricing, believes that inflation is close to peaking and that a few more Fed hikes, will – aligned with the falling inflation – bring the two in line.

So rates will be above inflation by mid-2023 and interest rates at this level will be restrictive to economic conditions but not too restrictive. So short and shallow recession will ensue. The opposition counters that inflation is not likely to come fast enough and that central banks will have to hike interest rates further and more aggressively than the current market pricing before rates are decisively above inflation.

This group argues that the fed funds rate will have to be at the minimum above four and a half percent before the necessary inflation wringing out occurs. It will take actually quite a bit of time before we know which side is right. The adverse effects of higher rates take usually about a year to flow through in the economy.

In the meantime, the U.S. ten year yields are likely to trade in a broad range on both sides of 3%, with inflation data being the key driver. We wonder whether investors are giving a bit too much credence to arguments that the worst of inflation is behind us. In such an environment, our preference is to follow nimble trading strategies in their portfolios rather than align closely with one of these views.

The U.S. dollar has strengthened pretty meaningfully this year. It's up 2% against the Canadian dollar, 12% against the euro and a very meaningful 20% when measured against the Japanese yen. Now part of that U.S.-dollar strength can be attributed to a faster pace of interest rate hikes by the U.S. Federal Reserve, and in general, just higher interest rates in the U.S. relative to its trading partners.

But it also has to do with weaker economic conditions abroad. We've seen a renewed lockdown of COVID restrictions in China, for instance, and that's weighed on the economic outlook in that country. And we've seen an energy crisis in Europe that's weighed on both business and household spending. These are things that can persist for a while longer. So it's possible that this U.S.-dollar strength continues into early next year.

But it's clear that in the long term, these U.S.-dollar moves are stretched and we would expect that the foreign exchange market narrative in a year's time will be one in which the U.S. dollar is weaker. We think that because a lot of the elements that we look at in our framework are long-term in nature. And these long-term elements suggest that the bull market in the U.S. dollar that started in 2011 to now a decade old is at or very near its end, and that the U.S. dollar is extremely overvalued and that overvaluation will now present an obstacle to further gains in the U.S. dollar.

So we think the greenback will sell off in the coming year and that leaves room for other developed market currencies to appreciate. Among those, we think the Canadian dollar can appreciate most, as that currency is supported by a hawkish central bank of its own, by healthy immigration and by a positive balance of payments capital flows that remain very positive for the currency.

Our forecast is for the dollar Canada exchange rate to hit 1.19 in 12 months, and that generally equates to a 9% gain in the Canadian dollar.