Richter survey of bank forecasts: Foreign exchange and interest rates

March 2018

Loonie faces uncertainties; additional stimulus weighs on USD

The CAD struggled in March, tumbling to its lowest point against the Greenback since June 2017. Among the contributing factors are the uncertainty surrounding trade with the United States and the dovish comments made by the Bank of Canada (“BoC”) Governor Stephen Poloz on March 14 where he highlighted that “the Canadian economy is carrying untapped potential that could prolong the expansion without causing inflation pressures"[1] reinforcing the notion that it is unlikely that the BoC will move forward with additional interest rate increases at this time.

National highlights concerns that NAFTA, the Canadian housing sector, and corporate tax cuts/deregulation in the U.S. are combining to foster a climate of uncertainty. National does however remain optimistic that the CAD has room to appreciate amidst USD weakness which is likely to be reinforced by a sharply deteriorating U.S. budget deficit, projected to soar past US$1 trillion, or more than 5% of GDP in 2019. Scotiabank noted additional uncertainties affecting the Loonie, including the loss of tax competitiveness with the U.S., relative changes in the countries’ regulatory regimes, and increases in provincial minimum wages. In the United States, BMO warns that the additional GDP growth as a result of the Bipartisan Budget Act, Tax Cuts, and Jobs Act is fueling inflation risks given that the economy is already sporting a positive output gap and expanding at an above-potential pace. Overall, the surveyed banks lack consensus as to the future of the pair, forecasting between 76.9 and 83.0 US¢/CAD by end of 2019.

A “patient, persistent, and prudent” ECB

At the Watchers Conference in Frankfurt on March 14, the European Central Bank (“ECB”) President Mario Draghi reiterated the ECB’s stance that it would not raise rates until “well past” the end of its Quantitative Easing (“QE”) program. However, Draghi highlighted that for the QE to end, “we need to see a sustained adjustment in the path of inflation towards our aim, which is a headline inflation rate of below, but close to 2 percent over the medium term" adding that until “further evidence that inflation dynamics are moving in the right direction… monetary policy will remain patient, persistent and prudent.[2] Therefore, at least for the near term, monetary stimulus in the European Union will remain.

CIBC anticipates that the EUR shall begin trading stronger in the second half of the year, and pick up pace in 2019. As such, CIBC is forecasting the pair to trade at 58.1 EUR¢/CAD by the end of 2019. National noted that the EUR also stands to benefit from USD weaknesses, but warns that the path of the currency over the coming months won’t be linear, with events such as Italy’s March elections expected to periodically fuel volatility. Overall, the surveyed banks remain divergent as to the future of the currency pair, forecasting it to trade anywhere between 58.1 and 64.0 EUR¢/CAD by the end of 2019.

Fed remains on course with March hike; BoC actions less certain

As widely anticipated, the FOMC opted to increase rates on March 21, and set the stage  for two more hikes in 2018. They reaffirmed their plan to gradually reduce the size of their balance sheet. BMO is anticipating three additional rate hikes in the wake of the Bipartisan Budget Act; however cites concerns over inflationary and protectionist measures. In Canada, the forecasting banks lack consensus on the timing of the next rate hike, with BMO, TD and CIBC expecting the BoC policy to remain on pause until the second half of this year. RBC, Scotiabank, National and Desjardins are all expecting a May hike.

2-year government yields to continue to trending higher

As at the date of the publication, the 2 year government bond yielded 1.76% and 2.31% in Canada and the U.S. respectively. Since last months’ publication, the banks made minor downward adjustments to the 2 year government bond yields in Canada, while upwardly adjusting the U.S. bond yield forecasts. As TD highlighted, the upward adjustment to the Treasury yield curve forecast is to account for greater inflation and interest rate risk, resulting in a higher term premium. Overall, the general forecast trend of 2 year government bond yields is to continue to increase in both the U.S. and Canada.

 

Budget deficit in the U.S. puts upward pressure on the 10-year yields

Compared to last month, we observe minor downward adjustments to the 10 year government bond yield forecasts for Canada. Conversely, comparable yield forecasts in the U.S. were increased as the new Fed Chairman Jerome Powell provided a rosy assessment of the U.S. economic outlook to the House of Representatives. Powell’s confidence in the economy led to an increase in the 10 year U.S. Treasury bond yield, reaching a high of 2.92%. National highlights the increase in government debt issuances as adding to the upward pressure on U.S. 10-year yields. Overall, the 10 year government bond yields are anticipated to steadily rise through Q4 2019 in the U.S. and Canada.

Long bond yields to rise in U.S. amidst tight labour markets and rising inflation risks

Consistent with the 2 and 10 year bond yield forecasts, the U.S. long term government yield forecasts were noticeably revised upwards. National sees the FOMC easing up on the brake in view of the headwinds to growth that can be expected from rising long term rates. Among the various factors contributing to rising bond yields in Canada and the U.S., BMO highlights further tightening labour markets and rising inflation risks. Overall, the surveyed banks are forecasting the long bond yields to reach anywhere between 3.08% and 3.45% in Canada, and 3.35% and 3.70% in the United States.

 

 

 

 

 

 

 


 

[1] https://www.bankofcanada.ca/2018/03/canadian-economy-carrying-untapped-potential/

[2] https://www.ecb.europa.eu/press/key/date/2018/html/ecb.sp180314_1.en.html

 

 

 

 

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