Richter survey of bank forecasts: Foreign exchange and interest rates

July 2016

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CAD/USD trade in narrow range despite financial markets volatility

In light of the impending global uncertainties, the Fed moderated expectations of any imminent rate hikes at their June 14th-15th meeting, tempering the strength of the USD. However, as the UK shocked markets in a long awaited referendum and voted to leave the European Union on June 23rd, the demand for the Greenback, the world’s major reserve currency, surged as investors sought a flight to safety from post-Brexit uncertainties. Additionally, crude oil fell from over $50/barrel before the vote to settle around $45/barrel by July 19th, weakening the CAD. The currency pair traded in a relative narrow range despite no shortage of volatility in the financial markets as a result of these opposing forces, opening at 76.4 and closing at 76.9 US¢/CAD for the month of June.

With respect to the reporting bank forecasts, RBC adjusted the tail end of its forecast from 80.0 to 76.9 US¢/CAD to reflect a more bearish 2017 year end outlook for the Loonie. Additionally, National made several downward adjustments, including significantly lowering their 2016Q3 forecast from 80.0 to 73.0 US¢/CAD. According to the narrative from National, the adjustments are intended to reflect the USD benefitting from periods of heightened uncertainties and stress in financial markets due to its safe-haven properties. The remainder of the forecasting banks left their outlooks relatively unchanged, but it should be noted that both CIBC and Desjardins published their forecasts on June 20th, prior to UK’s referendum, so any post-Brexit adjustments on their behalf remain to be seen.

Fears renewed on future of Eurozone; CAD/EUR outlook uncertain
The results of the UK referendum on June 23rd renewed fears as to the future of the European Union. Questions surfaced whether other countries may hold their own referendums, raising additional uncertainties as to the future value of the EUR. TD revised its forecasts to reflect a relatively weaker EUR at all points through 2017, attributing the British referendum as a game changer for the UK that will likely drag down European growth substantially. Further, in its publication, BMO raised the concern that Brexit may inspire other countries to hold their own referendums, and that uncertainties and low inflation will likely keep the ECB on high alert, and thus the EUR grounded. As a result the EUR’s perceived weaknesses, BMO sees the CAD trading at 74.6 EUR¢/CAD by the remainder of this year.

For the current publication, the reporting banks, with the exception of CIBC, now largely anticipate the CAD to either remain near current valuations or strengthen against the EUR through 2017. Although CIBC appears as the outlier, it should be reiterated that CIBC’s forecasts were published prior to the Brexit vote, and as such will be worth monitoring to determine if they will be revised to reflect these new economic fundamentals.

Hike expectations grow less likely in midst of global economic uncertainty
On June 28th, Fed Governor Jerome Powell spoke on monetary policy considerations in light of recent economic developments. In a dovish tone, he mentioned monetary policy will need to remain supportive of growth and that Brexit has the potential to create new headwinds for the U.S. economy. Thus, it is not surprising to see downward revisions on the expectations of the level of future Fed rate hikes. As for the Canadian overnight rates, the reporting banks maintained or reduced their policy rate expectations, with only CIBC and BMO forecasting a rate hike through 2017. National, one of the banks that retracted its rate hike forecast by 2017, said despite anticipating the Canadian economy to accelerate in Q3; the Brexit turmoil now poses more risks to the future economic outlook. Should such uncertainties persist, it will be worthwhile monitoring whether any banks begin to forecast a cut in the Canadian overnight rate.

2 year rate forecasts adjusted downward, reflective of falling yields
The 2 year U.S. Treasury yield slipped to 0.68%, while the 2 year Canadian government bond fell to 0.50% by July 18th as global economic uncertainties continue to reinforce the need for accommodative monetary policy. According to Fitch Ratings, $11.7 trillion of global sovereign debt sported negative yields in June, up dramatically from $1.3 trillion in the prior month. BMO mentions that given the proliferation of sub-zero yields, even record-low yields in America now look attractive to income-seeking investors. The reporting banks all revised down their forecasts for these 2 year government bond yields, with some banks making very significant revisions. RBC for example slashed its 2017 year end 2 year Canadian government bond yield forecast by more than half, from 1.85% to 0.80%, and the equivalent 2 year U.S. Treasury from 1.95% to 1.25%. Going forward, the reporting banks anticipate 2 year yields to eventually pick up through 2017.

Long bond yields fall; likely remain lower for longer
As government bond yields fell across the board, the 30 year Treasury and Canadian long bond were no exception. Long bond yields have now fallen steadily for several consecutive months as the global economic picture has grown more grim and uncertain, and an increasing number of global sovereign debt now yields negative returns. TD comments that markets are likely over attributing the degree of downside pressures to the U.S. economy related to events in Europe and potential risk aversion, adding that the U.S. economy is much better positioned on economic fundamentals than its peers. This picture is likely going to keep long bond yields lower for longer than previously anticipated, but the reporting banks eventually do see yields picking up from current levels as observed in the forecast.

British Pound makes history as UK votes to leave European Union
The British Pound (“GBP”) made history as it fell 8.4% in a single day of trading following the UK’s vote to leave the European Union. Just to add context, the previous single day drop for the GBP was 4.1% in 1992 when the GBP was forced out of Europe’s exchange rate mechanism. Following the vote, Prime Minster David Cameron announced his intention to resign, and the Bank of England stepped in with accommodative intentions by signaling that rate cuts may be on the horizon, and in lowering capital requirements for lenders. Governor Mark Carney dubbed these measures a “major change” in light of a “tougher economic outlook” for the UK. As the UK now enters the lengthy process of negotiating its leave from the European Union, many uncertainties arise. According to BMO, the GBP will remain under pressure, but as the UK’s future relationship with the European Union becomes clearer, the GBP will regain some lost ground. The reporting banks show a wide range of forecasts, with Scotiabank and RBC forecasting further weakening of the GBP, while TD, BMO and National anticipate the GBP will regain some ground versus the CAD, but ultimately still fail to return to its valuation just before the referendum through at least 2017. The remaining two banks, CIBC and Desjardins, presented their forecasts prior to the UK’s vote, which likely explains why they have the most favorable view of the GBP relative to the other reporting banks.

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