CAD Update April 2021: Loonie Strength to Slow Down Amid Economic Recovery
Progress in CAD price action aligns with expectations as the Canadian dollar continues to rally on a robust economic recovery. Despite near-term adjustments, the outlook remains positive with expectations of a gradual fading in the speed of the rally. The Bank of Canada's hawkish stance sets expectations for earlier liftoff and emphasizes the need for a strong economic rebound to sustain a more aggressive CAD rally.
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CAD Update YOUR GLOBALFOREIGN EXCHANGESPECIALIST April 2021 Loonie to continue gaining but progress to slow Events and CAD price action since our February CAD outlook have evolved broadly in line with our expectations, with the loonie progressively rallying over the course of the year on a more robust economic recovery despite a sluggish domestic vaccine campaign. Although, since the outlook, our near-term forecasts have been slightly adjusted, largely to account for the time elapsed. Author Simon Harvey Senior FX Market Analyst +44 (0)203 650 6472 Simon.Harvey@monexeurope.com Looking ahead, we maintain our view of a cyclical and structural rally in the Canadian dollar. However, we expect the speed of the rally to start to fade as the loonie carves fresh multi-year highs over the course of the coming months, especially as earlier policy normalisation from the Bank of Canada is already in the price. Risks to this view are fairly balanced. In the near-term, continued lockdown measures in major provinces and a sluggish vaccine rollout pose downside risks to our loonie forecasts. However, we believe the effects of the near-term headwinds will be offset by financial markets pricing earlier policy normalisation from the BoC relative to peers, enabling the loonie to continue trading near multi-year highs despite the economy being subject to lockdown measures. Over the longer-run, even though earlier liftoff by the Bank of Canada poses upside risks, the BoC s bullish economic projections place a high threshold for the economic recovery to exceed in order to warrant markets pricing even earlier policy normalisation than already signalled. Monex s May USDCAD forecasts 1-month 31st May 2021 3-month 31st Jul 2021 6-month 31st Oct 2021 12-month 30th Apr 2022 USDCAD 1.24 1.22 1.21 1.20
CAD Update YOUR GLOBALFOREIGN EXCHANGESPECIALIST April 2021 Hawkish message from the BoC cements expectations of earlier liftoff but sets a high bar for the domestic recovery to clear for a more aggressive CAD rally The Bank of Canada struck a hawkish tone in their April meeting after they not only announced the tapering of their QE programme from C$4bn to C$3bn weekly, but also raised their growth estimates and their estimates of when economic slack will dissipate, all while revising up their estimate of potential output from 1.4% to 1.6%. Markets enjoyed the tone of the BoC s communications; the loonie rallied the most since June 2020 with USDCAD breaking below the 1.25 handle, the 2-year spiked 5.7bps before retracing, and the OIS curve rose. Despite this, the loonie has struggled to consolidate gains of late, with the overall rally starting to lose steam. The reason for this is twofold: Firstly, the Canadian currency is sitting near a 3-year high. Any additional gains are likely to meet resistance as much of the markets optimism has already been priced in, while shorting USDCAD has quickly become an overcrowded trade. Secondly, domestic headwinds stemming from lockdown measures in major provinces suggests a structural leg lower in USDCAD is unlikely until progress is made to reopen the economy again. With the Bank of Canada now starting to normalise policy while providing a reasonable timeframe for markets to expect liftoff in rates, the markets focus is likely to shift from monetary policy back to domestic Covid-19 and vaccine developments. These developments hold the key for the timing and magnitude of the economic recovery, with the Bank of Canada expecting an almost stagnant quarter of growth at 3.5% QoQ annualised in Q2. Beyond the second quarter, however, the Bank of Canada is banking on a robust economic rebound. Their projections of 6.5% GDP growth in 2021 underlines their expectation of economic slack dissipating in H2 2022. However, the Bank is one of the most bullish forecasters in the market, with most private institutions anticipating growth in the region of 5.9%. In this light, the BoC has raised the bar that the economic recovery needs to exceed in order to warrant an even earlier pricing of rate liftoff. This trims the upside risks to our loonie forecasts over the medium-to-long run. The Bank also places a heavy burden on the government to vaccinate its population in Q2 in order to allow a broad based economic recovery in the remainder of the year.
CAD Update YOUR GLOBALFOREIGN EXCHANGESPECIALIST April 2021 The Canadian economy has been highly receptive to the marginal reopening phases throughout Q1, with the labour market fully recovering in all sectors except food and accommodation services. business sentiment intentions have been rising and the Q1 Business Outlook Survey suggests the Q1 While the Bank of Canada s economic projections are on the bullish side, they don t come without foundations. Meanwhile, investment and the Q1 Business Outlook Survey suggests consumers anticipate spending more than a third of savings accrued throughout the last year in the coming two years. With the Federal budget outlining continued support for the labour market and investment plans for the coming years, risks to a more robust economic recovery than anticipated still remain, although they are now more balanced given the Bank s forecast adjustment. Lockdown measures will naturally slow the loonie rally in Q2, with the signs of reopening key for the next leg lower in USDCAD In the near-term, USDCAD is unlikely to take another leg lower below the 1.24 handle without domestic economic conditions improving. For this to occur, the strain on provincial healthcare infrastructure needs to ease. Lockdown measures already in place will likely result in this partially occurring in the coming weeks, however, for a broader and longer-term reopening of the economy, Canada s rate of vaccinations needs to maintain the current faster pace. Our latest projections suggest that Canadian authorities are now on track to meet their target to fully vaccinate the most at risk 14.5m citizens by June 30th, however, supply issues have been rife recently and pose a downside risk to this projection. Additionally, the distribution of vaccine administration has seen major provinces like Ontario and Quebec, where lockdown restrictions are the tightest, lag in the race to vaccinate. Canada on track to meet end of June target, which should allow broader reopening in late Q2/ early Q3 but vaccine distribution has been uneven
CAD Update YOUR GLOBALFOREIGN EXCHANGESPECIALIST April 2021 In this context, it is likely that lockdown measures will only be marginally scaled back in major metropolitan areas over the coming weeks, while social distancing and partial lockdown measures remain in place until a greater proportion of the population are vaccinated. We don t envisage this occurring until the back-end of Q2/ early part of Q3 at the current vaccination pace. In this regard, lockdown measures are likely to drag on Q2 GDP as the Bank of Canada projected, which should increase the resistance the loonie rally faces in the near-term. Bank of Canada to continue tapering C$1bn a quarter as long as economic outlook is met, room remains to continue current pace if not The Bank of Canada s latest decision to taper their QE programme fell in line with our expectations. However, Governor Macklem s decision to link the tapering to the improvement in economic conditions since the turn of the year caught many by surprise. The market consensus was broadly for a C$1bn taper in the BoC s QE programme, but was expected due to technical reasons. That is, the Bank of Canada was rapidly approaching the 50% ownership of all Canadian government bonds ceiling that has been hinted as a soft limit in recent communications the BoC entered April s meeting owning more than 40% of all Canadian government bonds. However, with the weekly minimum purchase limit dropped to C$3bn, and new debt issuance to increase by C$181bn over the next fiscal year, the Bank of Canada now doesn t run the risk of reaching that ceiling by year-end. This suggests to us that additional tapering will therefore be conditional on the economic recovery following the BoC s projected path outlined in April. Should this occur, we expect the BoC to taper C$1bn a quarter, with the announcement presented at every meeting where the Monetary Policy Report is released. This would leave all communication channels open to the BoC s disposal when presenting the next incremental tapering. Such a timeline would see the BoC enter the reinvestment phase in 2022 Q1, leaving over a quarter to assess economic conditions before the markets attention turns to the projected rate lift-off in H2 2022. Under such a scenario (scenario 2), the BoC would hold just 41.6% of the overall Canadian government bond market on its balance sheet by year-end, assuming a constant rate of issuance every month. However, technical parameters won t force the BoC to continue tapering this year unless economic conditions justify the need to remove monetary stimulus. Should the BoC continue to purchase C$3bn per week until year-end, the central bank would only hold 45% of the overall market on its balance sheet.
CAD Update YOUR GLOBALFOREIGN EXCHANGESPECIALIST April 2021 This should, in our view, leave enough room for tapering to occur in 2022 before the ceiling is reached and a technical halt to the QE programme is embarked upon. Although, we only expect this scenario to play out should the economy fail to get close to the BoC s forecasts this year. Bank of Canada won t be forced into a technical taper this year, but expect QE to be tapered by C$1bn a quarter should the recovery meet the BoC s expectations Note: Share of bond market is based upon projected purchases under the below scenarios and an average issuance of C$15bn in CGB s monthly as per the FY21/22 plans. Scenario 1 the BoC continues adding C$3bn to its balance sheet weekly until year-end Scenario 2 the BoC tapers purchases by C$1bn at every alternate meeting where an MPR is released until year- end. A programme of C$1bn per week is carried over into 2022. Disclaimer This information has been prepared by Monex Europe Limited, an execution-only service provider. The material is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is, or should be considered to be, financial, investment or other advice on which reliance should be placed. No representation or warranty is given as to the accuracy or completeness of this information. No opinion given in the material constitutes a recommendation by Monex Europe Limited or the author that any particular transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research, it is not subject to any prohibition on dealing ahead of the dissemination of investment research and as such is considered to be a marketing communication.
