Canada: Economy growth widening? – Deutsche Bank

In view of analysts at Deutsche Bank, applying the lessons of the GFC to Canada has proven a painful experience with USD/CAD rising a few big figures to 1.38 before collapsing to 1.32.

Key Quotes

“This time around, the tightening of monetary condition comes primarily from depleting foreign reserves compensated till now by Quantitative Easing. The difference between now and the GFC is by far better balance sheets and much lower leverage in Developed Markets. More importantly, expected growth and inflation remain low as the payoff of leveraging is a fraction of what it once was, given that productivity remains weak. This in turn keeps sovereign curves in well managed economies extremely well contained driven by tepid long-term growth and inflation expectations.”

“Applying the lessons of the GFC to Canada has proven a painful experience with USD/CAD rising a few big figures to 1.38 before collapsing to 1.32. For one, leverage outside of consumers is not much of an issue and the oft-mentioned alternate mortgage industry is a small fraction of the overall market. What does matter is that new comers such as new households and immigrants spend a larger proportion of their wealth on housing. Saddled with debt, their consumption is likely to stay moderate in an application of the precautionary savings concept; namely that higher volatility in wealth leads to higher savings. This seems a wider issue, lower to middle income consumers without sufficient job and income certainty are likely to stay cautious.”

“As growth widened in Canada, the market started repricing the Canada curve, though remains 35bp from the three rate hikes we expect by the end of 2018. We believe it is too early for a July hike as the BoC will likely want to see another quarter of data in order to gain confidence that recent economic momentum is sustained. The most likely time to hike is October 25 given a press conference and forecast meeting. Hence, after a period of undershooting, we may see USD/ CAD drift gently higher towards 1.34.”

“Lower oil prices should dampen demand and lead to a lower CAD hedging demand close to month-end. Canada’s current account remains in deficit and lower oil prices won’t help as could lower EM demand driven by possible taper tantrum. In the short term, USD/CAD has stopped trading as a function of oil prices which is economically non-sensical. It is less so when one considers that the currency market tries to latch on to the winning strategy in the short term, namely trading USD/CAD as a function of minute differences in monetary policy expectations between the Fed and the Bank of Canada. Portfolio fixed income inflows into Canada remain considerable but are most likely hedged, while we have seen significant repatriation in the last print partly in somewhat unhedged equities.”