Strengthening U.S. economy and dovish BoC creates headwinds for CAD
The Bank of Canada (“BoC”) published its Monetary Policy Report on October 25th where it announced that largely due to the robust pace of growth in the first half of the year, the projections for Canadian economic growth have been increased to 3.1 per cent this year and 2.1 per cent in 2018. However, despite the strong economy and a rise in inflation, the BoC slammed the brakes on further rate hikes. Specifically, Governor Poloz highlighted the economy’s heightened sensitivity to higher interest rates given today’s debt levels, and that the prospect of a shift toward protectionist trade policies is the most important source of uncertainty affecting the outlook.
As noted by National, the Loonie depreciated 2.5 per cent against the Greenback in October, marking it as the worst monthly performance this year, despite the rally in oil prices. Further, Scotiabank is forecasting a weaker Loonie, citing the gradual pace of monetary tightening in Canada and increased certainty of higher rates in the US. CIBC shares Scotiabank’s views and notes that as market pricing for a near-term BoC hike fades, so too should the Loonie. Overall, the reporting banks are in consensus on the US¢/CAD near-term outlook and many have lowered their year-end target for 2017 to reflect a weaker Loonie.
The ECB begins a dovish tapering
At the October 26th meeting, the European Central Bank (“ECB”) announced an extension of its Quantitative Easing (“QE”) program, but reduced its monthly asset purchases from the current €60 billion to €30 billion from January through September. In addition to outlining its plan for its balance sheet, the ECB reiterated that policy rates shall likely remain unchanged “well past the horizon of our net asset purchases.” Despite the dovish stance, ECB’s president, Mario Draghi, highlighted an upbeat tone that the economic expansion in the Eurozone continues to be solid and broad-based.
From the reporting banks, National highlights that the EUR was hammered by QE extension, and expects it to weaken for the second consecutive month in October. National and Desjardins add their concern about EU-UK trade wars as a result of Brexit, which they say could produce major headwinds for the Eurozone, even disrupting the global economy. CIBC is more optimistic about the EUR stating that with the ECB’s QE announcement, the market focus will now shift toward when the first hike might take place which should support the currency. Overall, the surveyed banks lack consensus as to the future value of the EUR, with CIBC forecasting 62.0, EUR¢/CAD by the end of 2018, while RBC sees 72.0 EUR¢/CAD for the same period.
BoC unwind while the Fed is likely to hike
BoC announced on October 25th that Canada’s monetary policy will remain unchanged. As such, the surveyed banks, with the exception of Desjardins, are in consensus that the BoC will not hike at its next interest rate meeting on December 6th. In the United States, Jerome Powell was elected as the new Fed Chairman, however the market is expecting little change in Fed orientation as Powell is viewed as a safe bet who will follow in Yellen’s footsteps. The next Fed rate hike is expected on December 13th along with the start of normalizing its balance sheet. BMO highlights that this temporary policy downshifting reflects increased Fed caution concerning running two policy normalization programs at the same time.
2-year government yields relatively unchanged in the U.S., downwardly adjusted in Canada
The Fed’s expected rate hike in December is already reflected in the 2 year government yields and thus forecasts remained relatively unchanged. National highlights that the odds are improving that U.S. inflation will accelerate to higher levels than the market is pricing in, implying that yields will drift up further in coming months. In Canada, given the BoC’s dovish language, in contrast with the Fed, the 2 year Canadian bond yields were downwardly adjusted for end of 2017 by majority of the surveyed banks. RBC remains on the high end of the Canadian and U.S. estimates, forecasting the bond to yield 2.45% and 2.70% by end of 2017, respectively.
The 10-year government bond slides in Canada while holding steady and rising in the U.S.
The 10-year government bond yields continue their rise in the U.S., but are trading lower than previously forecasted in Canada. National attributes this to a combination of slower third-quarter growth, along with dovish BoC comments and lower than expected budget deficits. As at November 14th, the 10 year government bond is trading in the U.S. around 2.4%, up 0.20% from September, while in Canada it is trading around 1.98%, down 0.18% from September. According to the surveyed banks, Canadian 10 year government bonds are expected to yield between 2.25% and 3.05%, while the U.S. 10 year Treasuries are expected to yield between 2.70% and 3.40% by the end of 2018.
Long bond yields relatively unchanged in Canada and the U.S.
Compared to last month’s survey, the long bond yield forecasts saw minor revisions by the banks. Overall, and consistent with previous monthly surveys, the forecasting banks are in consensus that long bond yields will steadily rise through to end of 2018. RBC is on the high end in both Canada and the U.S., forecasting the yields to reach 3.30% and 3.75% by end of 2018, respectively.
* The dates of publications (which we include in the footnote) are:
- Canadian Interest rates: 11/14/2017
- U.S. Interest rates: 11/14/2017
- FX: 11/14/2017
- RBC – 11/03/2017
- CIBC Outlook – 10/23/2017
- Scotiabank – 11/03/2017
- BMO – 11/08/2017
- National Bank: November 2017
- TD Outlook – 10/26/2017
- Desjardins : 10/23/2017
* Laurentian forecasts and CIBC’s long bond yield forecasts were not available at time of publication. *