Richter survey of bank forecasts: Foreign exchange and interest rates

September 2017

The Loonie gains as Canada’s economy is on fire  

In a September 6th announcement, the Bank of Canada (“BoC”) highlighted stronger than expected recent economic data and more widespread strength in business investment and exports. The BoC then added that significant geopolitical risks and uncertainties surrounding international trade and fiscal policies remain, leading to a weakening U.S. dollar against a basket of major currencies. In light of this and the strength of Canada’s economy, the BoC raised the overnight lending rate this month and the Loonie has appreciated. As at the date of publication, the Loonie is trading at 82.1 US¢/CAD.

Surveying the commercial banks, we see that Scotiabank is expecting the Canadian dollar to appreciate to 83.0 US¢/CAD by end of 2017 and rise further to 87.0 US¢/CAD by end-2018, which places it on the high-end amongst the surveyed banks. This is based on Scotiabank’s hawkish view on Canadian monetary policy, stating that interest rates will rise more rapidly than expected, narrowing the rate differential between Canada and the U.S. amidst a continued global move away from the USD. CIBC, on the other hand, is less optimistic about the future of the Loonie, stating that the best days for Canada’s currency will soon be behind us. CIBC warns that the start of NAFTA renegotiations could see a new source of volatility in the Loonie as investors digest the back and forth.  This has raised concerns, particularly in Quebec and Ontario, given the importance of international trade with the United States. This wide-range of forecasts is relatively uncommon for the CAD/USD, highlighting uncertainty.

ECB strikes a dovish tone

The governing council for the European Central Bank (“ECB”) held a policy meeting on September 7th opting to keep interest rates unchanged, and reiterated a prior position that it stands poised to increase its Quantitative Easing (“QE”) program if necessary. ECB’s president, Mario Draghi, said that a substantial degree of monetary policy remains until the end of December 2017, or beyond, if necessary. Draghi added that “This autumn we will decide on the calibration of our policy instruments beyond the end of the year.”[1] We eagerly look forward to the ECB’s October rate meeting as Draghi set the stage for a big October announcement.

BMO highlights that the strength of robust and broad-based European economic growth has yet to spill over into stronger inflation dynamics. BMO underlines that any lift to the Euro will be limited by expected Fed tightening and uncertainty around the impending elections in Germany and Italy. National raised its targets for the EUR to reflect an improved economic outlook. In addition to the upcoming elections, Desjardins references the difficult Brexit negotiations with the U.K., and added worry about the stronger Euro. In a review of this month’s survey we note that National highlights that the Euro struggled to capitalize on momentum, citing a lagging southern European economy, Brexit, and the upcoming elections. Overall, amongst the surveyed banks, the currency is forecasted to trade anywhere between 63.1 and 72.5 EUR¢/CAD through the end of 2018.

The BoC hikes once more

The BoC increased its overnight rate by 0.25% with a September 6th hike, citing stronger than expected economic data, and in doing so marked the reversal of its two rate reductions of 2015. However, the BoC stated that “given elevated household indebtedness, close attention will be paid to the sensitivity of the economy to higher interest rates.”[2] The BoC’s next interest rate meeting is on October 25th however, BMO suspects that the BoC will likely take a brief pause to gauge the impact of the recent rate hikes. There is a consensus amongst the surveyed banks that the BoC will hold off any further rate hikes until its December 6th interest rate announcement. In the United States, all eyes remain focused on the Fed, with the consensus that the Fed will announce the October start of its balance sheet normalization program.

Canadian 2-year government reach new high since June 2011

Following the second rate hike in three months, the Canadian 2 year bond yield reached its highest since June 2011 at 1.64% on September 11th, before closing at 1.54%. Since last month’s publication, the surveyed banks increased their last month’s forecasts to the Canadian 2 year bond yields through the end of 2018. Regarding U.S. rates, TD, BMO and National downwardly adjusted their forecasts to the U.S. 2 year bond yields through end-2018, with TD highlighting that inflation will take longer to reach the Fed’s target, necessitating a slightly slower pace for the Fed’s policy rate goals.

10-year government bond rise in Canada 

Consistent with the 2 year bond yields, the forecasts amongst the surveyed banks were adjusted to reflect an increase in the Canadian 10 year bond yield and a decrease in the U.S. 10 year bond yields.  Overall, in both Canada and the U.S., the 10 year bond yields are anticipated to rise steadily through year end 2018, with TD highlighting that the spread between them will eventually narrow. The Canadian 10 year government bond is forecasted to yield between 2.45% and 3.00% by end-2018. In the United States, the 10 year government bond is forecasted to yield between 2.65% and 3.40% for the same period.

The U.S. long bond yield decreases, while the Canadian remains relatively unchanged

Last month, the Canadian and U.S. long bond yields were 2.26% and 2.80% respectively. At the date of publication, we observed an increase in the Canadian long bond yield to 2.43% but a decrease in the U.S. long bond yields to 2.77%. Notably, all of the surveyed banks, with the exception of RBC, have lowered their forecasts for the U.S. long bond yields. Therefore, RBC remains on the high end of the forecasts of the surveyed banks, expecting Canadian and U.S. long bond yields to rise to 3.25% and 3.75% respectively, by 2018 year-end.

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