Richter survey of bank forecasts: Foreign exchange and interest rates

January 2017

CAD rebounds as crude oil rally extends gains; uncertainty looms

Heading into 2017, the CAD managed to regain ground against a surging trade-weighted USD on the heels of a convincing rally in crude oil prices, a significant Canadian export. Crude oil prices have now nearly doubled since their 2016 lows, as many factors, including an agreement by OPEC to curb oil supply have helped support prices. Meanwhile, the persistent strength of the Greenback has been largely attributed to the strengthening outlook for the U.S. economy, the increased expectation of impending Fed rate hikes, and U.S. President Trump’s signaled intent to introduce substantial fiscal stimulus into the economy. As at the date of the publication, the currency pair traded at 75.6 US¢/CAD.

Laurentian comments that they expect the commodity rally to continue in 2017 and the Fed to seek to mitigate further appreciation of the USD, both factors which support their projections of a stronger CAD. The remaining surveyed banks expect a weaker CAD through the first half of 2017, at which point the forecast consensus becomes less clear. National is skeptical that the USD will maintain its momentum, citing potential defaults of USD denominated debts which could put a lid on its appreciation. On the other hand, BMO indicates the possibility that the USD could soar if trade protectionist measures are implemented. As such, given the obvious uncertainty and presence of near term catalysts, we encourage business owners to take pre-emptive measures by hedging their currency exposure where merited.

Political uncertainty driving currency forecasts; challenges and opportunities on horizon

On a month-over-month basis, the CAD/EUR currency pair is little changed, trading at around 71.5 EUR¢/CAD, as at the publication date. The lack of consensus amongst surveyed banks indicates that uncertainty continues to be the main theme of 2017. The currency pair is forecasted to trade anywhere between 62.6 and 75.5 EUR¢/CAD over the forecast horizon. According to BMO, their cautious outlook stems from the political front - in particular after the Brexit vote and the election of Trump. It will be worth monitoring a number of key European elections this year that could reveal populist movements. The Netherlands’ March election will give the first such indication as Geert Wilders’ anti-EU Party for Freedom gains in the polls. Populist movements are gaining traction in France, where a presidential election is set for the spring, with current President Hollande confirming he will not seek re-election. Further, Italy is also seeing divisive movements, with several anti-EU opposition parties gaining momentum. Germany’s elections on the other hand appear to be less uncertain; Chancellor Angela Merkel expected to secure another term. For those with business interests in Europe, it is important to understand the possibility of this changing political landscape in order to avoid pitfalls, and to capitalize on new pockets of opportunity.

Bank of Canada may gradually hike rates in 2018, bank surveys show

National reports that in December Governor Stephen Poloz stated that he never imagined the Canadian economy would still be this far from full capacity, adding that “a significant amount of slack remains” in the Canadian economy. As such, it seems fitting that the surveyed banks would anticipate the monetary stance to remain accommodative through 2017. Going forward, however, several banks are forecasting the end of a low-interest rate environment and a gradual normalization of the Bank of Canada’s policy stance by 2018. This is in line with the Bank of Canada’s October Monetary Policy Report which expects the output gap to close around mid-2018. In the U.S., the consensus remains that the Federal Funds Rate will rise through 2018. It is our view that Canadian businesses will continue to benefit from a lower interest rate environment, but should begin planning for managing the possibility of higher borrowing costs in the medium term.

2 year bond yields rise, upward adjustments made

As at the date of the publication, 2 year government bonds yielded 0.72% and 1.17% in Canada and the U.S., respectively. There was a slight retraction in yields following the surge after Trump’s victory. We observe that upward adjustments were predominantly made to both Canadian and the U.S. yield forecasts by the reporting banks to reflect this higher yield environment and new expectations. The surge of the U.S. bond yields largely reflect the expectation that deficit-financed fiscal stimulus will spur faster growth and higher inflation. Although this expectation largely stems from the U.S., Canadian bond yield forecasts were pulled along, albeit at a slower pace. Generally, there is a consensus that 2 year bond yields should rise over the presented two-year forecast horizon in both Canada and the U.S.

Rising yields signal economic optimism, but also tighten financial conditions

In December of last year, Governor Stephen Poloz said “it’s absolutely a case that rising bond yields, which will translate into rises in mortgage rates here in Canada, represent a tightening of financial conditions…” suggesting that rising global bond-market interest rates are leaning against the Bank of Canada’s simulative low-rate policies. The yields on Canadian and U.S. 10 year government bonds have increased materially since the beginning of 2016Q4. Positive economic signs were beginning to manifest even before the presidential election. The U.S. economy is back on track after a disappointing first half of 2016, with real GDP growth of 3.2% in the third quarter, and the unemployment rate falling to the lowest level since the recession. Should Trump’s pro-growth agenda dominate, and the Trudeau administration play their cards right, we see ample opportunities being created for Canadian businesses south of the border.

Long term yields to rise at gradual pace

Consistent with the 2 and 10 year bond yield forecasts, long term government bond yields are also anticipated to rise steadily in both Canada and the U.S. Although several banks revised their forecasts for higher yields, they acknowledge downside risks due to the incoming U.S. administration, citing tighter immigration and more restrictive trade policies as inflationary, but likely negative for U.S. growth over the long term.

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