Bank of Canada holds, USD tested by protectionist policies
Despite weaker than expected Q1 GDP growth, the Bank of Canada (“BoC”) upwardly revised its outlook over the next two years due to stronger investments, a rebound in exports and as a result of anticipated fiscal policy tailwinds. Additionally, the BoC on April 18 opted to maintain the overnight rate at 1.25%; highlighting that “higher interest rates will be warranted over time, although some monetary policy accommodation will still be needed to keep inflation on target.” The Loonie traded notably lower after the announcement, closing at 79.3 US¢/CAD on the announcement date.
Regarding the United States, National commented that despite a strong U.S. economic performance, the USD is depreciating at the fastest pace in a decade as a result of protectionist policies of Washington and mounting deficits. In Canada, National noted that despite the pick-up in world oil prices, the Loonie is among the worst performing major currencies this year, losing almost 3% against the USD in Q1 - making it the worst quarterly depreciation in over two years. Attributing factors include concerns about NAFTA, the housing market and the sustainability of consumption growth. Scotiabank is more concerned about trade tensions between the United States and China as an escalation in trade measures could have very significant implications. Overall, the currency pair is forecasted to trade between 76.0 and 83.0 US¢/CAD by end of 2018 with most surveyed banks holding or slightly lowering their forecasts.
The ECB is in agreement as to the future of its QE program, but remains flexible
The Governor of the Banque de France (also a member of the European Central Bank (“ECB”) Governing Council) said that the ECB is in support of ending the Quantitative Easing (“QE”) program. He highlighted an adverse loop of protectionist threats, unfavorable exchange-rate movements, and abrupt financial-markets corrections as possible reasons to remain flexible in future scenarios. CIBC highlighted that the EUR is up nearly 10% against other major currencies in the last year, which could soon put the brakes on growth by real exports, and warns of the risk in the surge of U.S. government protectionism and potential for retaliation from Europe and U.S. comebacks. Scotiabank is forecasting the Eurozone GDP growth to outperform expectations, despite some softening in upstream indicators. National added that the EUR will benefit from USD woes, which saw an increase in speculators long positions on the common currency to a new record in March. Overall, despite the forecasted continued growth in the Eurozone and possibility to an end to QE programs, a lack of consensus as to the value of the CAD/EUR currency pair through 2019 continues to exist.
BoC holds; Fed on gradual rate hike path
As was widely expected, the BoC held its key monetary policy interest rate at 1.25%, but the message remains that the BoC is still set on further rate hikes this year. Most of the surveyed banks are expecting at least two more hikes during the remainder of the year, with the exception of CIBC calling for only one more hike. CIBC anticipates that the BoC will require evidence that the new mortgage regulations aren’t too disruptive before continuing its tightening path.
In the U.S., there is evidence of strong U.S. economic performance, which is paving the way for the Fed to tighten monetary policy yet again. Overall, the forecasting banks are in consensus as to further Fed rate hikes, with BMO forecasting another three times this year, but reiterating prior concerns over inflationary measures.
US-Canada yield spread widens; upward trend remains intact
Since last months’ publication, we observed downward adjustments were largely made to the Canadian 2 year government bond yield forecasts. Conversely, the 2 year government bond yield forecast in the U.S. was upwardly adjusted by CIBC, Scotiabank and Desjardins. Desjardins attributes the wider Canada-U.S. yield spread to the more hawkish FOMC story than that of the BoC. Despite the adjustments in Canada, the 2 year government bond yields are still expected to gradually increase in the U.S. and Canada through 2019.
Yield spread between 2 and 10 year government bond tightens, risk of inverted yield curve looms
An instance in which the yield on the 2 year exceeds the yield on the 10 year government bond is referred to as an inverted yield curve. Such yield curves have become infamous as important leading recessionary indicators, and consequently observers of financial markets pay close attention to them. Scotiabank highlighted that flattening yield curves are likely, but does not expect the yield curve to invert. Overall, the 10 year government bond yields are forecasted to yield between 2.6% and 3.1% in Canada, and 3.2% and 3.8% in the US by the end of 2019, just above their 2 year counterparts. These figures reflect a slight downward revision over expected yields from last month’s publication.
Long bond yields downwardly adjusted in both Canada and the U.S.
Consistent with previous monthly surveys, the forecasting banks are in consensus that the long bond yields are to increase through 2019. Notably, all of the surveyed banks, with the exception of CIBC, have lowered their forecasts for both the Canadian and the U.S. long bond yields. CIBC highlighted that long rates will be pressured should markets start to focus on the upcoming end to QE in Europe and a potential for major central banks to begin tightening policy earlier than they now assert. BMO remains on the high end of the Canadian forecasts, whilst RBC remains on the high end of the U.S. forecast, expecting the long bond yields to rise to 3.2% and 3.9%, respectively.
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