Loonie edges lower as Canadian economy cools from torrid pace
There was no stopping the Canadian economy as of late, which witnessed widespread growth prompting the Bank of Canada (“BoC”) to hike the overnight rate twice since July. As a result of the stronger Canadian economy, coupled with the BoC’s rate hikes and higher oil prices, the Loonie appreciated 7.34% against the Greenback in Q3 (Q3 average vs Q2 average). This was the biggest quarterly gain since 2004 for the Loonie, as noted by National. However, TD highlights that Canada’s economy is cooling from its red hot pace of activity in the first half of the year, and data show export volumes falling in August, a third straight month of decline. As a result of a generally softening economic outlook and emerging NAFTA uncertainties, the Loonie edged lower against the USD to 80.1 US¢/CAD, 2.4% lower than last reported in our September publication.
National stated that the Fed hikes are not priced-in by markets and, hence, expects the Greenback to rise next year against the Loonie with U.S. inflation. Additionally, National warns that Canada’s main source of financing is short-term capital, which leaves the Canadian economy vulnerable to sudden shifts in investor sentiment and makes the Loonie more volatile. CIBC is also calling for a weaker Loonie in the coming quarters, highlighting that policy makers are cautious following the two rapid-fire interest rate increases. On the other hand, Scotiabank retains a generally negative view of the outlook for the USD, due to weak growth and persistent market doubts about the Fed’s willingness to tighten monetary policy. Desjardins also is more bullish on the Loonie, stating that the BoC could enact another rate hike in October and as such it increased their year-end target for 2017 to 85.0 US¢/CAD. Overall, the surveyed banks do not appear to have a consensus as to the path of the currency pair from here.
Draghi defends decision; key meeting ahead
Amid criticism regarding last month’s European Central Bank’s (“ECB”) decision to keep the interest rate unchanged, ECB’s president, Mario Draghi, defended his position stating that, maintaining interest rates “well past” it’s Quantitative Easing (“QE”) program “is very, very important in anchoring rate expectations.” Moreover, Draghi expressed confidence in returning inflation to the ECB’s goal, stating “[the ECB is] confident that as the conditions will continue to improve, the inflation rate will gradually converge in a self-sustained manner, as we’ve defined many times, and in a durable way to our objective.” His statements carries significance as the ECB is set to decide the future of its stimulus policy at the upcoming October 26th meeting.
CIBC is calling for the ECB to taper its QE purchases following the October meeting, which in terms of restrictionary policies, would strengthen the Euro. Scotiabank warns that despite the Eurozone’s recent economic strength, political risks such as regional independence issues and Italy’s general election in May 2018 remain, potentially putting a restraint on Euro gains. For similar political reasons, National does not see a lot of upside for the Euro from current levels over the forecast horizon. However, National highlights that business and consumer confidence as measured by the European Commission’s Economic Sentiment Index is the highest in a decade, and that Eurozone employment levels are at all-time highs.
Weak inflation suggests caution for the Fed, while all eyes are on the BoC
The surveyed banks appear to be divided on a possible third rate hike announced on October 25th at the BoC’s next interest rate meeting. CIBC, BMO and Laurentian are calling for the BoC to pause for the remainder of the year, with CIBC labelling the latest BoC’s hikes as “aggressive bets,” and BMO citing household debt and a “too strong” Loonie. In the United States, CIBC is expecting the Fed to help the Greenback hold its ground, stating that the Fed is expected to start normalizing its balance sheet and hike interest rates, despite persistent shortfalls in inflation.
Canadian and U.S. 2-year government yields anticipated to increase
Since last month’s publication, the forecasts for Canadian and U.S. 2-year government bond yields remained relatively unchanged. Given the increase in Canadian yields, TD raised the question whether consumers are getting the message to ease up on spending. Scotiabank highlighted that the forecasted Fed and BoC hikes will continue bear, flattening the 2-year slopes of each country’s yield curve. Desjardins continues to expect the Canadian and U.S. yields to rise and is on the high end of the Canadian estimates, forecasting the 2-year Canadian government bond to yield 2.45% by 2018 year-end. RBC is on the high end of the U.S. estimates, forecasting the bond to yield 2.70% for the same period.
Inflation hinders the 10-year government bond rise in the U.S.
The 10-year U.S. government bond appears to remain under the clouds of inflation. BMO cautions that stronger or weaker inflation than expected in the U.S. would have major consequences for the bond market. On the other hand, Desjardins labels the bond yields as “very weak”, but remains optimistic, citing a stronger performance by the U.S. economy and gradually rising inflation. TD also attributes weaker yields to less than anticipated inflation, a low term-premium and an overall high level of demand for U.S. Treasuries as a result of QE. National expects the Canada-U.S. 10-year yield spread to narrow only slightly. Overall, the reporting banks are forecasting the Canadian and U.S. yields to rise through 2018-end.
Long-bond yields expected to continue to rise through 2018
Overall, the same factors affecting the 10-year U.S. government bond are affecting the long bond yield, which include weak inflation and a low term premium. However, the long bond yield in both Canada and the U.S. are forecast to increase through last quarter of 2017 and during 2018. Desjardins upwardly adjusted its Canadian long-bond yield forecast, reaching 3.30% by 2018-end. Overall, the surveyed banks maintain a consensus that the long-bond yields are expected to rise gradually through 2018-end in both Canada and the U.S.
* The dates of publications (which we include in the footnote) are:
- Canadian Interest rates: 10/12/2017
- U.S. Interest rates: 10/12/2017
- FX: 10/12/2017
- RBC – 10/06/2017
- CIBC – 10/13/2017
- Scotiabank – 10/05/2017
- BMO – 10/05/2017
- National Bank: October 2017
- TD Outlook – 09/21/2017; Bottom Line: 10/06/2017
- Desjardins : 09/19/2017
*Laurentian forecasts for CAD/EUR or USD/EUR were not available at time of publication.*