Don't Be So Downbeat on Loonie, Top Currency Forecaster Says

(Bloomberg) -- The outlook for the Canadian dollar has become far too gloomy, according to the currency’s top forecaster.

Lloyds Banking Group Plc expects the loonie to bounce after posting its worst start to the year against the U.S. dollar relative to its peers as pessimism lifts over the North American Free Trade Agreement and expectations for rate hikes from the Bank of Canada begin to creep back into the market.

“We’re seeing some progress on the Nafta front,” said Gajan Mahadevan, a London-based strategist at the bank. “The risk to the Bank of Canada outlook is now probably skewed to the upside, especially after the recent jump in inflation.”

The loonie fell 2.6 percent against the greenback in the first quarter, lagging 15 other major currencies tracked by Bloomberg, and traded around C$1.273 per U.S. dollar at 10:35 a.m. in Toronto. It will advance 2.6 percent to C$1.24 by the end of this year and to C$1.20 in 2019, according to Lloyds.

Don't Be So Downbeat on Loonie, Top Currency Forecaster Says

The currency has been under pressure this year as the economy slowed and investors cut bets for interest-rate increases. Concerns that negotiations to overhaul Nafta would fall apart have also weighed on the currency, though as of last week, Lloyds’s optimism was looking well placed.

Canada, the U.S. and Mexico are making progress in Nafta talks, which have entered “a new, more intensive stage of engagement,” Canadian Foreign Minister Chrystia Freeland said Friday after meeting with her U.S. and Mexican counterparts in Washington. Mexico’s Economy Minister Ildefonso Guajardo said Monday there is an 80 percent chance there could be a Nafta agreement in principle by May, while Larry Kudlow, U.S. President Donald Trump’s top economic adviser, said progress is being made.

Rate Forecasts

Lloyds is more bullish than other Canadian dollar watchers. The loonie will strengthen to C$1.25 by the end of the year, according to a median of forecasts compiled by Bloomberg. And hedge funds and other speculators last month turned bearish on the currency for the first time since July, according to the data from the Commodity Futures Trading Commission.

Investors wager there’s a 22 percent chance of a rate increase at the central bank’s policy meeting on April 18, swaps trading suggests, down from 40 percent two weeks ago, while a hike in July isn’t fully priced in. In his latest speech from March 13, Bank of Canada Governor Stephen Poloz said the central bank’s latest decision to keep interest rates on hold reflected comfort with recent data.

Acclerating Inflation

Yet inflation in February accelerated to an annual pace of 2.2 percent, the highest in three years, even as the economy contracted in January. Data on Friday showed the economy created a higher-than-expected 32,300 jobs in March, keeping the unemployment rate at 5.8 percent, the lowest in four decades.

Adding to the optimism, the Bank of Canada’s first-quarter survey of executives out Monday showed expectations for future sales have improved, with companies seeing continued signs of capacity constraints and labor pressures. The country’s consumer confidence also rose, as shown by the weekly Bloomberg Nanos Canadian Confidence Index.

Dark Cloud

Global economic growth will remain robust this year, which should help drive crude oil prices higher and support the Canadian dollar, according to Isaah Mhlanga, a Johannesburg-based economist at Rand Merchant Bank, which came in second in the Bloomberg ranking of forecasters. The ranking is based on calls for the first quarter.

Mhlanga sees long-term fair value of the Canadian dollar at around C$1.17 per greenback and expects the currency to strengthen to C$1.22 by the end of the year. He doesn’t expect the Bank of Canada to hike as aggressively as the market anticipates, seeing just one more rate increase this year compared to the market pricing in two.

“If you combine one rate hike and commodity prices picking up, that should be bullish for the Canadian dollar,” he said.

Bears say Nafta could still unravel and come back to plague the loonie. The currency will probably weaken up to C$1.31 per the U.S. dollar over the next two quarters, according to Juan Perez, a Washington-based senior foreign exchange trader and strategist at Tempus Inc. which came third in the ranking of forecasters.

“Because of Nafta being such a dark cloud and the U.S. economy being resilient and consistent, it weighs on the Canadian dollar in a negative way,” Perez said. “I don’t think the Canadian dollar has much that could improve its situation in the next six months.”

For now though, things are looking up on the future of the North American trade bloc, according to Lloyds’s Mahadevan.

“There was a psychologically based drive to price in a huge degree of risk around Nafta and after President Trump temporarily exempted Canada from the steel and aluminum tariffs, we’ve seen some of that pullback,” he said.

©2018 Bloomberg L.P.