Canadian Dollar Forecasts Cut as Trade Concerns Escalate and “Captain Hawk” Becomes “Doctor Dove”

International trade risks are mounting and the Canadian interest rate outlook has deteriorated, leading analysts to cut their forecasts for the Loonie and warn of further losses to come.

The Canadian Dollar stabilised against its G10 rivals during noon trading in London Wednesday although it remains close to a two year low against the Pound and seven month low relative to the Dollar, while strategists are warning of further losses to come.

A key risk to the Loonie at the moment is a possible escalation of trade-tensions with Washington and between the US and the rest of the world.

Canada caught a lucky break earlier in March when President Donald Trump exempted the country, as well as Mexico, from new tariffs of 10% and 25% respectively that the White House imposed on imports of aluminium and steel into America.

Including Canada in the tariff order would have been damaging for the country’s economy given that the US is its largest export market for metals, with approximately $12 billion of steel being shipped south of the border annually.

However, the reprieve may prove short-lived as Canadian Prime Minister Justin Trudeau is reported to have said Tuesday that Canada could be forced to replicate President Trump’s tariffs on imports from the wider world.

This would be in order to ensure the country is not used as a conduit into the US for foreign steel producers seeking to evade the White House’s new levies.

“Late yesterday, Canada’s Prime Minister aired the risk that Canada would be forced to enact its own steel tariffs to prevent Canada acting as a conduit for dumped steel that is then sold into the US economy,” writes John Hardy, head of FX strategy at Saxo Bank, in a note Wednesday.

"USDCAD ripped back higher towards the 1.2950 level as the market considers the consequences for Canada caused by Trump’s “carveouts” on tariff policy."

The USD/CAD rate was quoted 0.14% lower at 1.2948 Wednesday while the Pound-to-Canadian-Dollar rate was 0.20% lower at 1.8064.

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Protectionism Adds to NAFTA Risk

Metal tariffs, which were defended by Commerce Secretary Wilbur Ross here, are just part of a broader push toward more trade protectionism currently underway at the White House.

They followed a January decision to impose tariffs on washing machines and solar panels, but came ahead of a Reuters report that suggested Wednesday, the President is about to impose a wave of tariffs against imported consumer goods from China.

Fears are that so called protectionist tariffs will draw retaliation from other countries, raising the spectre of a so called trade war. Indeed, the European Union and China have already warned of a likely response given that they have been impacted by the levies.

“The Trump Administration’s announcement of steel tariffs puts a spanner in the NAFTA renegotiation works. Those talks need to go on a freeze from April through December to accommodate the Mexican election. Now that freeze appears likely to be filled with headline risk,” says Greg Anderson, an FX strategist at Canada’s BMO Capital Markets.

Protectionism at the White House comes amid efforts by the White House to renegotiate the North American Free Trade Agreement, which President Trump described as “the worst deal in history” when on the campaign trail.

There are a number of aspects to the existing NAFTA agreement the US President has taken issue with while numerous other analysts have speculated that a US withdrawal from the pact could lead to a double digit devaluation of the Canadian Dollar.

“The true challenge for Canada in the next year will be to come unscathed from the NAFTA renegotiations while also navigating a turbulent housing market along with households carrying record-high debt loads. Quite a balancing act for a central bank that's in a hiking mode,” says Fred Demers, chief Canada macro strategist at TD Securities.

With the the seventh round of NAFTA negotiations having concluded without a breakthrough on the key issues in March, and the 2018 Mexican presidential election campaign set to get underway at the end of April, uncertainty about the fate of the trade pact looks set to be left hanging over the Loonie like a Damocles Sword until year-end.

“We have recently noted that the market needs to curb its enthusiasm in CAD; economic growth should decelerate while Canada's largest trading partner is leaning towards more protectionist policies. NAFTA negotiations remain unresolved and still far apart on the contentious issues,” adds Demers.

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“Doctor Dove” Can’t Cure the CAD

Adding further gloom to an already dour outlook for the Canadian currency is a recent and ongoing deterioration in market expectations for interest rates during the quarters ahead.

The Bank of Canada raised interest rates to 1.25% in January, the third increase inside nine months, and at the time markets were optimistic about the idea of it following up with a further two rate hikes before the year is out.

However, while analysts had widely predicted the next rate increase would come in May and be followed by another one toward year end, recent weeks have seen investors and traders become less confident in this thesis.

“Recall that the Bank has highlighted in its last [monetary policy review] that protectionism is the greatest risk to its outlook, and that fear appears to be unfolding. Until this ebbs, the current backdrop warrants a defensive stance in CAD and is one of our preferred positions in the G10 against the USD and the crosses,” Demers writes, in a note Wednesday.

Pricing in interest rate derivatives on January 17, the day when the BoC last raised rates, implied an April 18 cash rate of 1.44% and a May 30 cash rate of 1.49%. The implied rate for October was 1.78%.

However, this implied April rate had fallen to 1.31% by 08:00 am on March 14 and the May cash rate dropped to 1.36%. The implied October cash rate has gone from 1.78% to 1.64%.

“CAD is on the cusp of a renewed down-leg. Though there was no new substantive information in Governor Poloz's speech, the market appears to have finally heeded the message that there is no urgency for the Bank to tighten anytime soon. We continue to view July as the earliest hike,” says Mazen Issa, an FX strategist at TD Securities.

In addition to trade risks, a Tuesday speech by Bank of Canada governor Stephen Poloz has also been credited with driving Canadian interest rate expectations into the floor.

Poloz spoke about the modern labour market at Queen’s University in Ontario, where he argued that youth participation in the jobs market could be greatly improved, placing a question mark over the idea that the Canadian economy is close to full employment.

This speech earned governor Poloz a new moniker among the team at TD Securities, who used to refer to him as "Captain Hawk" but have now crowned him "Doctor Dove" in reference to policymakers who prefer lower interest rates over higher rates. 

Participation in the labour market and the concept of full employment matter for currency markets because they impact on central bank expectations for wage growth, which is a key driver of inflation and therefore, interest rates.

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Forecasts for USD/CAD, GBP/CAD 

Demers, Issa and the TD Securities team are flagging the 1.30 seven month high for the USD/CAD rate as a key level that will be important for currency markets over coming days and weeks.

This marks an important psychological level for traders and should the exchange rate break convincingly above it, a further move up as far as 1.32 could occur in quick succession.

“A move through 1.30 in USDCAD would complete a reverse head and shoulders, and pave the way to a 1.32 extension. Note that this broadly coincides with trend resistance from the 2016 highs,” Issa writes Wednesday.

“Given the overall challenging USD backdrop however, we would expect to see CAD weakness to be exacerbated on EUR and JPY crosses, both of which offer a better strategic risk/reward profile.”

This is while Gallo and the BMO Capital Markets FX team have revised almost all of their short term Canadian Dollar forecasts downward. Although they expect the USD/CAD rate to fall from its current level, they predict the Pound will continue to rise against the Canadian currency over the next 12 months.

BMO forecasts the USD/CAD rate will fall back to 1.26 in the coming weeks and remain close to that level for around nine months, before falling to 1.22 some time in the first quarter of 2019 as a NAFTA deal is wrapped up. 

“We think a NAFTA breakup would push USDCAD to 1.35+. We think negotiations will last into at least mid 2019,” BMO's Anderson writes.

This is while the Pound-to-Canadian-Dollar rate is seen declining from the 1.80 level seen this Wednesday to around 1.78 in three months time before rising steadily back to 1.80 in six months and to 1.86 by year end.

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