Loonie Forecasters Still Buying Theory Trade Turmoil Will Pass

(Bloomberg) -- Count foreign exchange analysts among those betting global trade ructions will blow over, at least for the loonie.

The Canadian dollar is hovering near a one-year low against its U.S. counterpart as President Donald Trump’s tariff adventures and concerns over Nafta’s potential unraveling cut the odds for interest-rate increases in Canada. But forecasts call for a rebound by the end of the year as global growth wins out as the currency’s driving force.

“There is a pretty significant Nafta discount being applied to the Canadian dollar,” according to Shaun Osborne, chief foreign-exchange strategist at Bank of Nova Scotia in Toronto. “Any pain in the Canadian dollar is likely to be transitory.”

Investors turned bearish on the loonie, weakening it to C$1.3382 per U.S. dollar last week, the lowest since June 2017. But the currency is poised to end this year at C$1.28 and strengthen further to C$1.24 by the end of 2019, according to forecasts compiled by Bloomberg. That would be a more than 7 percent gain by the end of next year from current levels, the biggest increase in eight years.

Loonie forecasters remain convinced Trump’s tariffs against its trading partners will eventually be removed and the U.S., Canada and Mexico will agree on a new North American Free Trade Agreement.

Tariffs Spread

Domestic pressure from U.S. quarters on Trump to do an about-turn will be key, said Peter Hall, chief economist at Export Development Canada, pointing to an anti-tariff campaign begun by the Koch brothers. “When some of your best friends start to mount a direct attack on policy that you’ve come up with, that’s when it’s revealed what the actual cost is to American businesses,” Hall said.

EDC expects the Canadian dollar to strengthen to 78 cents, or C$1.28 per U.S. dollar, by the end of the year and further to 80 cents, or C$1.25, by the end of 2019.

Trump isn’t letting up on his mission to rewrite the global trade order yet. He’s slapped tariffs on China and imports of steel and aluminum from Canada and the European Union. Canada is set to retaliate with tariffs of up to C$16.6 billion on U.S. imports. Canada, Mexico and the U.S. remain committed to negotiating a new Nafta deal, but talks have essentially stalled since May and there is still no consensus about much of the agenda.

Confidence Eroding

Still there are signs pressure is starting to pile up on Trump. Harley-Davidson Inc. said it plans to shift some production of its motorcycles out of the U.S. in response to retaliatory European Union tariffs, while the shares of Brown-Forman Corp. fell to this year’s low as the maker of Jack Daniel’s is forced to raise prices for American whiskey sold in the European Union. Some manufacturers in Texas are worried U.S. steel tariffs will hurt a robust industry expansion as producers face building wage and price pressures, a Federal Reserve survey showed.

The trade fracas has dented consumer confidence in Canada and helped reduce the odds for an interest-rate hike on July 11 to about 50 percent this week from almost 80 percent earlier in June, though those odds had crept back up to almost 60 percent on Tuesday. Bank of Canada Governor Stephen Poloz may provide more clarity on the future path for rates in a speech and press conference Wednesday.

Grey Swan

If trade tensions continue to rise -- Trump’s threatening tariffs on auto imports, which would permanently scar the Canadian economy, according to Toronto-Dominion Bank -- the loonie would tumble. A repeal of Nafta would push the Canadian economy into recession and send the currency to as much as C$1.40 per U.S. dollar, said Karl Schamotta, director of foreign-exchange research and strategy at Cambridge Global Payments.

“There would be an initial and devastating shock,” Schamotta said. “It’s not a black swan anymore, it’s a grey one,” he added, referring to a term coined by Nassim Nicholas Taleb to describe a random occurrence that’s very difficult to predict.

Schamotta views the dissolution of Nafta as the less likely scenario. Still, the initial suffering it would cause would turn into a positive for Canada in five to 10 years as companies would look further abroad in terms of their markets, making the Canadian economy more diverse and less dependent on one trade partner, he said.

In the meantime, help for the loonie will come from other factors, including an improvement in the global economy, a rise in commodity prices and eventually higher interest rates in Canada, according Osborne, who sees the currency strengthening to C$1.25 per U.S. dollar by year-end.

“We do assume we will get a Nafta agreement at some point and once we get some clarity on that, assuming a positive outcome, I would expect a fairly serious rebound in the Canadian dollar,” he said.

©2018 Bloomberg L.P.

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