Richter survey of bank forecasts: Foreign exchange and interest rates

June 2017

Loonie resilient despite sluggish commodities, economic headwinds/risks

Over the past month, the CAD managed to regain some value against the Greenback, and as at the date of publication, the CAD/USD currency pair traded near 74.2 US¢/CAD.  According to TD, they are expecting the CAD to appreciate gradually, citing that the Canadian economy is growing well above potential, with the economic improvements not yet reflected in the currency. As TD highlights, the CAD’s valuation is reflective of the risks surrounding the Canadian housing market and trade uncertainties with the United States. On the other hand, Desjardins states that it is expecting the CAD to remain near current levels, citing major uncertainties provoked by the upsurge of American protectionist sentiment, a troubling Canadian real estate market, high household debt, and uncertainties surrounding the future of NAFTA. National Bank mentioned that the Loonie’s appreciation is also attributable to the Bank of Canada becoming more hawkish (referencing the overheating housing market) and adding that May demonstrated that the CAD can flourish even with oil in the doldrums. Going forward, the banks are divided as to the path of the CAD/USD through the remainder of the year, but are in general consensus that the Loonie should appreciate, albeit modestly, relative to the Greenback by the end of 2018.

Sentiment improves but uncertainties persist

As National reports, there is increased confidence among both business and consumers in Europe as the European Commission’s Economic Sentiment Index reached its highest point in a decade. Further, TD adds that a clearer political picture, namely Macron’s victory in France has triggered some renewed optimism in the financial markets. However, TD also notes that there are still plenty of risks, and that a pullback in the European economy, the outcomes of elections in Germany, tough negotiations with the UK on Brexit, and persisting geopolitical risks all could disrupt the global economy. National adds that despite the improved sentiment, the ECB is not yet ready to tighten policy. Specifically, National recounts there is still plenty of room for improvement in the most vulnerable Eurozone economies where growth remains weak, and there is a risk of widening sovereign spreads again, in particular headlined by Greece bailout risks in July and Italy’s 2018 election which bear their own anti-EU opposition risks. As such, despite an improving political picture, there continues to exist a lack of consensus amongst the reporting banks on the future value of the CAD/EUR currency pair through 2018.

A hike is looming: Economic growth putting pressure on Bank of Canada

Compared to last month, we observe no changes in terms of the forecasts for the Bank of Canada overnight rates and little change to the Fed rates forecasts. National continues to expect the earliest Bank of Canada rate hike (as early as Q1 2018), however notes that there is a 40%+ chance the BoC will decide before year end that the time has come for a hike. Desjardins is still expecting two additional Fed rate hikes by year’s end, happening more quickly than previously reported. With the US economy continuing to pick up, and an expectation of real annualized GDP growth in excess of 3.0% during the second quarter as reported by TD, we should continue to anticipate a higher yield environment over the forecast horizon. In Canada, although the banks expect the Bank of Canada to remain on the sidelines through 2017, there is consensus that there will be multiple rate hikes through 2018 as the Canadian economy continues to strengthen.

2 year government bond yields to rise through 2017/2018

The Banks made minor adjustments made to the 2 year government bond yields for both Canada and US Notably, BMO downwardly adjusted the Canadian bond yield forecasts for Q3 and Q4 2017 and into Q1 2018, citing the underperforming non-energy exports and uncertainties surrounding the housing market as possible impediments to economic growth. As for US bond yields, Desjardins made upward adjustments to Q3 and Q4 2017 and Q1 2018, adding that despite real GDP only rising 0.7% in the first quarter, it is expected to rebound this spring. Overall, rates are expected to continue to rise in both Canada and the US through the remainder of this year, as well as the next.

Downward adjustments but higher yield environment ahead

Compared to last month’s publication, we observed downward changes in terms of the forecasts for the Canadian and US 10 year bond yields throughout the remainder of 2017 and 2018. TD cites the rollercoaster the markets went through last month due to President Trump and the FBI probe related to Russia as a cause, highlighting the risks related to confidence in the U.S. government’s ability to implement their pro-growth strategy. BMO downwardly adjusted their forecasts for 10-year yields by 10bps quoting the faded reflation trade in the wake of Trump’s firing of FBI Director James Comey, as well as the North Korean missile tests which prompted safe-haven demand for Treasuries. Overall, the 10 year yields should rise over the forecasted horizon in both Canada and the US.

Long bond yields to continue to rise

TD and BMO lowered their Canadian and U.S. long bond yield forecasts in Q3 2017, Q4 2017, and in Q1 2018. Protectionist sentiments remain a significant factor contributing to these revisions, as well as uncertainties surrounding the Canadian housing market. On the other hand, National appears to have faith in economic growth in Canada and the US, as they raised their forecasts throughout the remainder of 2017 and 2018, but did disclaim that their revisions are dependent on developments in international financial conditions and on incoming US indicators. In general, the reporting banks continue to anticipate higher and rising long bond yields over the forecast horizon.

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