The Canadian Dollar Rises after Economy Rebounds in February; Market Eyes Poloz Speech and Trade Tariffs

-CAD lifted by better than expected February GDP number of 0.4%.

-Trade tariff reprieve has also supported a buoyant Loonie on Tuesday.

-NAFTA and Bank of Canada outlook still key to medium term trajectory.

© kasto, Adobe Stock

The Canadian Dollar rose Tuesday as markets responded to a better than expected February GDP number and the latest developments around international trade, which saw Canada gain another exemption from White House tariffs on imported aluminium and steel.

Canadian GDP rose by 0.4% during the February month, marking a strong rebound back from a -0.1% contraction in January, when markets had been looking for growth of a lesser 0.3%. This draws a line under the earlier contraction which was believed to have been the result of transportation problems leading to lower activity in the energy sector.

Incidentally, Statistics Canada states it was a rebound in mining, oil and gas activity that drove the upturn during February, although a healthy rise in manufacturing and construction activity was also a factor.  

"The Canadian economy hit a pot-hole to begin the year, but February's GDP reading suggests that it was only a temporary bump in the road," says Royce Mendes, an economist at CIBC Capital Markets. "The better than expected GDP result could boost expectations for a rate hike in May, but markets will be closely watching Governor Poloz's comments on housing later today, a topic of major concern for monetary policymakers."

The GDP number matters for markets because the Bank of Canada has made clear in recent months that it will take its lead from growth momentum when it comes to inflation forecasts, rather the current level of inflation pressures and developments around commodity prices.

Accelerating demand in an economy can, after all, lead to higher inflation further down the line. As a result, Tuesday's GDP number will have the power to influence market expectations for interest rates during the months ahead.

The USD/CAD rate was quoted 0.05% higher at 1.2840 following the release, after having pared back an earlier 0.28% gain, while the Pound-to-Canadian-Dollar rate extended losses to trade 0.69% lower at 1.7548 due to the combined effect of a weak Sterling and better Canadian data. 

"We are biased to see a bit more downside in USDCAD given the cross-currents of the (unofficial) NAFTA deadline and the Iran nuclear deal over the next few weeks. An onconsensus GDP print would reinforce consolidation in the loonie, though we look to buy into dips towards 1.27 rather than chase USDCAD higher this week," says Fred Demers, chief Canada macro strategist at TD Securities.

Tuesday's GDP data comes a short time before Bank of Canada governor Stephen Poloz is due (19:30) to give a speech on household debt levels at the Yellowknife Chamber of Commerce, which could also be of significance for the Loonie given the relevance of household debt to the question of interest rates.

The Bank of Canada has previously flagged high levels of household debt as a risk to the outlook for consumer spending and the broader economy, which is a particularly salient point in a rising interest rate environment.

Poloz has always stated that the BoC will monitor the impact the BoC's recent interest rate rises have had on household financial positions in order to gauge the appropriate pace of future rate hikes.

The BoC has raised rates three times since July 2017 and, although economists have recently become less optimistic about the extent to which they will be raised again this year, markets are still looking for at least two more rate hikes in 2018.

"We expect another discussion on the risks of going too fast/too slow but don't expect Poloz to offer anything more explicit. Given the topic, we think it would be difficult for Poloz to sound overly upbeat," says TD's Demers.

Both the GDP number and Poloz's speech come hard on the heels of a decision by the White House to extend an earlier exemption that enables Canada and Mexico to avoid new tariffs on steel and aluminium imported into the US.

President Donald Trump announced tariffs of up to 25% on both products back in March, citing unfair competition in the form of state subsidies from some countries as well national security concerns.

Canada and Mexico were exempted until May 01 in the hope that a renegotiated NAFTA deal would be in the bag by this time and so both would benefit from a permanent exemption. However, NAFTA remains in limbo so the White House has compromised by extending the exemption until June 01.

"NAFTA headlines continue to be fluid, though recent 'soundbites' suggest an imminent deal might not be so, well, imminent," says Ian Pollick, a rates strategist at CIBC Capital Markets.

Representatives from Canada, Mexico and the US have been attempting to renegotiate the North American Free Trade Agreement for almost a year now and, according to many of the latest reports on the status of talks, are beginning to make some progress.

President Trump's dislike of the NAFTA agreement is well known after he described it as "the worst deal in history" when on the campaign trail. It was all but torn to pieces until late March when the White House was reported to have offered a key concession and begun pushing for a token agreement to be concluded some time this month.

This is important given analysts have previously estimated that a NAFTA withdrawal by the US could hit the Canadian economy hard and see the Loonie fall by as much as 20%. Conversely, the Loonie could also rise strongly if and when a deal is clinched.

Markets had been hoping for a deal to be done in early April and then, before the beginning of May, although the talks were still rumbling on Tuesday. With no sign of an imminent breakthrough. There are a range of key issues yet to be resolved. 

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