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Loonie Underpriced in Big Banks’ Eyes as 2017 Hike Risk Remains


October 25, 2017 by Alexandria Arnold

(Bloomberg) 

Wednesday’s Bank of Canada meeting is set to revive a six-month surge in the loonie that’s stalled in recent weeks, according to the country’s biggest lenders. That’s good news for speculators who remain near the most bullish on the currency since 2012.

Bank of Nova Scotia Chief Foreign-Exchange Strategist Shaun Osborne says the Canadian dollar is poised to rally to C$1.20 versus its U.S. counterpart by year-end, from about C$1.27 at 7:45 a.m. New York time, as traders who’ve been reducing expectations for a third BOC interest-rate hike in 2017 begin to price one back in. He’s joined by analysts at Royal Bank of Canada, Toronto-Dominion Bank and Bank of Montreal who all say the currency is poised to resume its ascent.

The market-implied odds of a December rate increase have slid below 50 percent, versus as high as 80 percent last month, according to overnight index swap data compiled by Bloomberg, fueled by a slew of weak data prints. Yet strategists expect rising wages and inflation, along with Canada’s progress in closing its output gap, will prompt the BOC this week to keep alive prospect’s for a year-end rate hike. Hedge funds and other large speculators agree. They boosted wagers on Canadian dollar strength to a net 75,086 contracts in the week ended Oct. 17, near the most in five years.

 

 

“The recent re-adjustment in BOC expectations, which leaves market odds for a December hike at around 50/50, suggests that risks are modestly underpriced now,” Osborne said. “The real issue is what the BOC says about the outlook for policy.”

The Bank of Canada will release its policy decision at 10 a.m. in Ottawa, accompanied by its latest Monetary Policy Report, which includes economic forecasts. A press conference with Bank of Canada Governor Stephen Poloz will follow. All 26 firms surveyed by Bloomberg expect the central bank to leave the overnight lending rate at 1 percent.

Positioning Clearout

Still, not everyone sees the loonie strengthening. Bipan Rai, a senior foreign-exchange and macro strategist at Canadian Imperial Bank of Commerce, says the currency will slip to about C$1.30 by the end of the year.

“The biggest risk right now for the loonie is that proxies for positioning and sentiment are close to all-time highs,” said Rai, who expects the Bank of Canada to refrain from further rate hikes in 2017. “In that scenario, we have to ask where the new marginal buyer is going to come from. We do think that USD/CAD will trade back lower into the middle of next year, but positioning needs to be cleared out.”

With momentum on the pair building, short-term moving averages turning higher and the spot price breaking above its 100-day moving average Tuesday, near-term targets lie around C$1.2778, the Aug. 15 high. In the other direction, a move back below the July 26-27 low of C$1.2414 would signal a shift in sentiment toward Canadian dollar strength.

Greenback Driver

Weakness in the U.S. currency rather than factors on the Canadian side are likely to be the primary catalyst for a slide in USD/CAD, according to BMO’s global head of foreign-exchange strategy Greg Anderson, who cited a market that’s gotten ahead of itself with regard to Federal Reserve tightening and a tax proposal that’s likely to be dollar-negative.

He expects the Canadian central bank to raise rates in January, following a December Fed hike, and sees the loonie rallying to C$1.24 by the end of December.

A shrinking yield gap between U.S. and Canadian two-year notes will also help fuel the loonie’s advance, according to Mazen Issa, a senior foreign-exchange strategist at TD in New York.

“If you’re a data-dependent central bank, the data suggests that you have room to hike,” Issa said. He expects the loonie to rally to C$1.22 versus the dollar by year-end.



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