Canadian Dollar Will Weaken on Mounting Fears Over US Protectionism Say Morgan Stanley

The Canadian Dollar is at risk of weakening because of Canada's disproportionate reliance on exports, which are under threat from US protectionism.

Analysts at Morgan Stanley have altered their stance on the Canadian Dollar and now see it as vulnerable to losses as a result of fresh concerns about the future of the NAFTA free trade agreement between the US, Canada and Mexico.

US President Donald Trump famously called NAFTA, "The worst deal in the history of the United States," and swore to renegotiate it more in US interests if elected to the White House.

Although talks are ongoing there have been increasing concerns that the US might simply walk away from the negotiating table and unilaterally tear up the agreement.

This comes amidst tough talk from the White House over China, who's burgeoning trade surplus, especially with the US, has revived threats from the US administration to increase tariffs on Chinese imports.

In the event of a lurch to more protectionism the biggest losers in the FX world, according to Morgan Stanley, would be the Canadian Dollar and the British Pound.

Both countries behind the currencies have high trade deficits, which would widen further if the US shut its doors to outside trade.

"Thus, the recent news suggesting a rising risk of protectionism, in a market environment of stretched risk asset positioning, may be the impetus for a correction in risk and a temporary break in the USD weakening trend," says Hans Redeker, Morgan Stanley's head of G10 FX strategy.

"In this environment, liability currencies like USD and JPY should experience support. Currencies most vulnerable to a pullback are those with a high sensitivity to trade and a current account deficit. CAD comes to mind here,as does GBP."

Updated Interest Rate Forecasts

As a result of their new stance on CAD Morgan Stanley have adjusted their forecast and now see USD/CAD rising above 1.30 in 2018.

"We enter a tactical USDCAD long targeting 1.30. Markets are beginning to discuss a higher risk of protectionism which should benefit CAD shorts.

Economic data, especially recent jobs data has been particularly strong in Canada and this argues for a stronger CAD, but the threat of protectionism outweighs any positivity until talks finish.

Trade is also the egine room of the economy at the moment and one of the reasons why the Bank of Canada (BOC) is contemplating raising rates as early as January.

Higher interest rates equals higher currency as the promis of higher returns attratcs foreign capital inflows.

"The BoC expects that exports will be a key engine of growth for 2018, meaning a headwind to trade could weigh on the market-implied path for BoC rate hikes, which we argue are priced fairly aggressively as is," says Redeker.

Morgan Stanley's projections of USD rising versus the Canadian Dollar, combined with their forecast for GBP/USD, suggest that although both currencies will weaken in 2018 the Canadian Dollar will fall more than Sterling.

This should translate into the Pound strengthening versus the Canadian Dollar  leading to implied rate of 1.58 for GBP/CAD in March 2018, rising to 1.66 in September 2018.

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