CAD: Modest strength ahead for the loonie - SocGen

Alvin T. Tan, Research Analyst at Societe Generale, explains that the Canadian economy started the year on a strong footing after a disappointing 4Q16 but the adjustment to lower oil prices is largely complete, and the Bank of Canada has noted a more positive tone to business investment recently.

Key Quotes

“The labour market has tightened over the past year, with the unemployment rate falling to 6.5%, which is the lowest level since 2008. The impact of the Liberal government’s fiscal spending programme should become more apparent in 2H17 as infrastructure spending ramps up.”

“However, much still bedevils the economy. Notwithstanding the declining unemployment rate, wage growth has not only been weak but has been tumbling over the past year. This has undercut the rise in inflation. On top of this, the housing market appears to be cooling. The financial difficulties at Home Capital Group Inc., which is Canada’s largest nonbank mortgage lender, and macro-prudential tightening measures have triggered a noticeable weakening in sentiment towards the property market.”

“The combination of weak inflation, housing market concerns and US uncertainties suggest that the Bank of Canada should stay on the sidelines through the rest of the year.”

“Despite the likely lack of interest rate support, there are a couple of major positives for the Canadian dollar in our view. The first is that crude oil prices are expected to rise moderately in the coming months. Our oil strategist believes that OPEC is back in the game of active supply management and that the cuts will work in time. The fundamental demand-supply picture for the oil market following the OPEC cut extension is indicating an implied inventory drawdown of 1 Mb/d for 2H17. Moreover, there are practical constraints to the medium-term growth outlook for US supply. Thus, we are forecasting the price of Brent crude to average $62.50/bbl in 4Q17. Given the tight link between the CAD exchange rate and oil prices, such a development would be positive for the currency.”

“Secondly, the Canadian dollar has cheapened considerably after underperforming since 2012. When you add this to our view that the trade-weighted US dollar peaked in 1Q17, it suggests that USD/CAD should decline into year-end. We expect USD/CAD to drop gradually to 1.30/1.32 by early 2018 despite the BoC being firmly on hold.”