Canadian Dollar on Front Foot ahead of Key NAFTA Deadline, Forecast to Appreciate against Pound Sterling

- CAD on front foot as electoral math puts May 17 NAFTA deadline in focus.

- Deal needed before May 17 for approval in Congress says Paul Ryan.

- Forecasts from Commerzbank see USD/CAD higher and GBP/CAD lower in 2018.

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The Canadian Dollar has entered the new week on the front foot, scoring gains over approximately half of the developed world currency basket as markets appear unfazed by a crucial May 17 deadline drawing near for the renegotiation of the North American Free Trade Agreement to be succesfully concluded.

A new NAFTA deal is important for the Loonie because analysts have previously estimated a withdrawal by the US could hit the Canadian economy and see the currency fall by as much as 20%. However, the July Mexican presidential election is now looming and US midterm elections are set for November, both of which are now putting negotiators' backs up against the wall. 

House of Representatives Speaker Paul Ryan said last week that negotiators have until Thursday May 17 in order to get the new deal finalised and voted through the US Congress before January. After then, it will become impossible to guarantee that the deal is approved in Washington, even if it is renegotiated in a way that is favourable to the US.  

“We have to have the paper — not just an agreement, we have to have the paper — from US Trade Representative by May 17 for us to vote on it this year, in December, in the lame duck session", Ryan told an audience at the Ripon Society, a Republican policy lobbying group in Washington.

This is because US electoral mathematics may become more complicated after the midterms if modern voting trends continue and the Democratic Party wins control of either the House or Senate in November. This would see a Republican NAFTA deal left at the mercy of Democrats in Congress for approval.

Either that, or it might leave President Donald Trump with no choice but to invoke powers vested in the Oval Office to terminate US participation in the current NAFTA pact, which would mean all of Congress must vote for the new deal or leave the US, Canada and Mexico with no NAFTA deal at all when the appropriate time comes. This would be sure to prompt a surge in volatility across Canadian Dollar exchange rates. 

"CAD will have to grapple with CPI and NAFTA headlines [this week]. The latter is turning seemingly less constructive as important deadlines loom," says Mark McCormick, North American head of FX strategy at TD Securities. "We hold our short CADJPY trade amid hopes of a shift in the JPY leg."

For their part, negotiators sounded their usual upbeat tones after meetings last week, reiterating the usual mantra of good progress with more work to be done, although this comes after nearly a year of negotiations that have so-far yielded very little in terms of tangible results. 

“The USA has come up with some initiatives that we believe are bad for Canada – but probably for the USA as well. We continue to work for Canada’s interests, believing that it is possible to achieve a win-win outcome,” says Justin Trudeau, Canada's Prime Minister, in an interview with Germany's Handelsblatt Monday.

With a number of key issues still on the table, particularly around the automotive trade, markets will watch closely this week for signs of a breakthrough.

"The threat of US protectionism has receded, after continued exemptions from aluminium and steel tariffs, as well as a more friendly tone in the NAFTA renegotiations, which are likely now to last into 2019," says David Meier, an economist at Julius Baer, who have told clients they see "clearer skies" ahead for the currency.

CAD Forecast lower against USD, Higher over GBP 

Assuming the hurdles to a succesful renegotiation of NAFTA can be navigated over coming days, relative economic growth and monetary policies are expected to return to the fore as the predominant driver of Canadian Dollar exchange rates over the months ahead.

This is likely to see the Loonie remain under pressure against its US rival but win new ground from Sterling and the Euro, according to the latest forecasts from analysts at Commerzbank, who have also warned that Canada securing a new NAFTA deal is paramount to their outlook for the Loonie. 

"Since we believe in an agreement, we also expect the BoC to continue its cycle of interest-rate hikes this year, which should support the CAD. Nevertheless, we expect USD-CAD to remain at elevated levels over the course of the year, mainly because the US central bank too will continue to hike rates this year," says Esther Reichelt, an analyst at Commerzbank. 

The Federal Reserve and Bank of Canada have both raised their interest rates three times each in the last year and are expected to have achieved at least three hikes each for the calendar year before 2018 is out. 

Traders are currently looking to the May Bank of Canada meeting for its next rate hike, with interest rate derivative market pricing implying an 100% probability the BoC will raise its cash rate to 1.5% on May 30. Those same markets also imply there is a 100% probability the BoC will raise its cash rate to 1.75% on October 24. 

However, question marks over the future of NAFTA mean these expectations are vulnerable to change, particularly if a deal has to wait until January before it can be ratified in Congress. This means the Loonie is likley to struggle for an advantage when stood next to the Big Dollar through the rest of this year.

"USD-CAD will continue to linger on high levels and even rise somewhat during the course of the year. The CAD is likely to only gain sustainably again against the USD in 2019, when the Fed starts to slow down its rate hike pace, while the economic environment should offer sufficient leeway for continued BoC interest rate hikes," Reichelt adds.

Still, while the Canadian Dollar won't fare too well against its US rival during the months ahead, Commerzbank forecasts suggest it should score some easy wins over the Euro and Pound.

This is given the European Central Bank is not expected to raise its interest rate until well into 2019 and the Bank of England may be stymied from further rate hikes by a softer economy and uncertainty over the outcome of the ongoing Brexit negotiations. That ties in with what others are saying about the Canadian Dollar for the rest of this year.

"Rising interest rates and less policy uncertainty open the door for the loonie to appreciate alongside a stronger US dollar, in particular against European peers such as the euro or the Swiss franc. We therefore recommend going long the CAD versus the CHF and EUR," says Julius Baer's Meier.

Commerzbank forecast the Euro-to-Canadian-Dollar rate will slip gradually from 1.52 Monday to 1.51 before year-end while the Pound-to-Canadian-Dollar rate should fall from 1.7355 Monday to 1.7160 before year-end. The EUR/CAD forecast is unchanged from the April month although the Pound-to-Loonie projection represents a downgrade from Commerzbank's April forecast of 1.7680 at year-end.

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