Uncertainty weighs as Trump, OPEC materialize
Trump’s economic agenda is largely driving the strength of the USD as markets price in the inflationary pressures that the proposed infrastructure spending, tax cuts and deregulation pledged by the President-elect will bring. Not to be outdone in recent weeks, the CAD regained some ground against the USD, supported by promising domestic economic data and in benefitting from OPEC’s recent agreement amongst key stakeholders to curb crude oil supply, an important Canadian export. As at the publication date, the currency pair traded near 75.0 US¢/CAD.
Reviewing the banks forecasts, we observe that National notes that it has little faith in the OPEC countries’ ability to follow through with the recent agreement, whilst Scotia, Desjardins and RBC also support a stronger USD through 2017. However, we also note that while the aforementioned banks revised their forecasts to anticipate the USD to rally versus the CAD through 2017, Laurentian remained optimistic on the Loonie, and TD and CIBC left their forecasts relatively unchanged. Recognizing this uncertainty, we advise that a prudent business practice would be to separate business risk from currency risk where possible. In doing so, thought should be given to engaging in currency hedging transactions.
European Central Bank maintains accommodative stance
The Loonie has appreciated over 12% relative to the Euro from January lows, and trades at 71.9 EUR¢/CAD as at the publication date. Following the December 8th meeting, the European Central Bank (“ECB”) Governing Council opted to keep key interest rates unchanged. In maintaining their accommodative stance, the Governing Council stated that interest rates will remain at present or lower levels for an extended period of time, and that the ECB will continue its asset purchase program in an attempt to regain the path of inflation. According to National, the further depreciation of the Euro is a possibility as uncertainties brought by the formal start of Brexit-related negotiations weigh on the common currency. Scotiabank further cites other factors as attributing to uncertainty, such as referendums on political reform and multiple national elections across Europe, which are on the horizon. Overall, the surveyed banks anticipate the currency pair to trade anywhere between 65.1 and 70.4 EUR¢/CAD, indicating an expectation of a strengthening CAD against the EUR from current levels over the next year.
Bank of Canada holds as Fed continues lift-off
On December 7th, the Bank of Canada opted to maintain the overnight rate at 0.50%, in line with the forecasts of the surveyed banks in last month’s publication. Canadian economic data suggests that global economic conditions have strengthened, and the domestic economy has shown a strong Q3 rebound with consumption growth and gains in employment. The Bank of Canada added that although housing imbalances continue to rise, the new housing finance rules should mitigate this over time. Of the banks surveyed, there is a consensus that the overnight rate will remain at 0.50% through 2017. On December 14th, the Fed increased the U.S. federal funds rate in line with expectations, signaling that the U.S. economy continues to strengthen. They added that they expect to raise rates three more times in 2017, up from their guidance of two at the September meeting. We note that the bank forecasts largely fall in line with the Fed’s guidance, as the federal funds rate is expected to steadily rise through 2017.
2-year bond yields rise in both Canada and the U.S.
The yields on 2-year U.S. government bonds have nearly doubled since July lows, whereas Canadian 2-year government bonds have also risen steadily since September. It is generally viewed that Trump will deliver on his pro-growth agenda, which in turn would create inflationary pressures and drive yields higher. However, not everyone attributes that the rise in yields is a Trump-story. TD’s suggests that no matter who was elected; the U.S. economy was on track to reach its potential. Never-the-less, the consensus remains that 2 year yields should continue to steadily rise in the U.S., and at a more reduced pace in Canada.
As yields rise, changing landscape may create pockets of opportunity
After a prolonged retraction through 2015 and the last half of 2016, yields on Canadian and U.S. government bonds have risen steadily and steeply. The Canadian economy is showing comforting signs, rebounding strongly in Q3, whilst U.S. political news supports a pro-growth and expansionary economic agenda. Desjardins adopts a cautionary stance by mentioning that although bond yields moved up following the U.S. presidential election, they remain low by historical standards, and several factors could push them higher yet. Overall, the surveyed banks anticipate the yields to continue to rise, albeit at a reduced pace through 2017. As the U.S. economy continues to recover, and should pro-growth policies be supported and implemented, this should also create pockets of opportunity for Canadian businesses with U.S. operations and/or customers.
As yields rise, so do challenges and opportunities
All surveyed banks increased their forecasts for U.S. and Canada long bond yields since last month; consistent with expectations of growth in U.S. economy and the strong Canadian recovery following a dismal start to the year. According to Scotiabank, U.S. growth is expected to remain otherwise broadly supported by mildly improving consumer spending, solid job growth, rising wages, income gains and stronger industrial activity. Scotiabank added that growth in Canada will likely remain a bit weaker due in part to modestly higher borrowing costs, but also noted that stronger U.S. economic performance and the lagged effects of Canada’s planned fiscal stimulus should support the Canadian economy. Business owners should seek to understand the rapidly changing financial landscape, not only to mitigate potential increases in debt financing costs and currency risks, but also in order to capitalize on strategic and imminent opportunities as a result of this very landscape. We are seeing clients seek to benefit from favorable Canadian monetary conditions (with low interest rates and a relatively inexpensive Canadian dollar) by focusing on exporting both goods and services to U.S. customers.
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