US: Going for BAT, or not – Deutsche Bank

Analysts at Deutsche Bank suggest that USDCAD trades mainly as a function of oil prices and differences in policy expectations between the Federal Reserve and the Bank of Canada but these should begin to diverge if a border-adjustment tax (BAT) is the centerpiece of a comprehensive US tax reform package.

Key Quotes

“While the Fed would look through a temporary BAT-induced inflationary spike, the Bank of Canada could be forced to react by cutting rates twenty-five basis points and possibly employ some sort of forward guidance to flatten the curve and weaken the Canadian dollar.”

“In an extreme case, the BoC could hint at Quantitative Easing. However, the sequencing and timing is highly uncertain—the BoC may wait to see if the dollar strengthens without BoC intervention. To be sure, in the absence of a BAT or a watered down version that made exceptions for key Canadian export industries—namely energy, Canada would likely still benefit from stronger exports on the back of strong US demand. In this scenario, our current base case of BoC rate hike by yearend, followed by further tightening in 2018, albeit at deliberately slower pace than the Fed, would remain intact. However, the downside risks to this base case are mounting as the probability of a BAT rises.”