While the loonie is still the top performer against the greenback in the G-10 this year, it has started to shed those gains. Economists at CIBC look for CAD to continue to unwind gains in the coming months as the Fed’s tone becomes increasingly hawkish relative to the Bank of Canada.
Monetary policy twice as effective in Canada due to higher household debt
“While the tone in the Treasuries market hints of growth concerns, these are more reflective of doubts about overseas economies. Stateside, past fiscal stimulus, pent up savings, and rising labour income should fuel a healthy consumer-led rebound in growth ahead. America’s much larger dose of fiscal stimulus and earlier reopening will see it eliminate economic slack a few quarters ahead of Canada, which is inconsistent with the market’s pricing for earlier and more aggressive rate hikes north of the border. A recalibration in those expectations will underpin a continued if modest depreciation in CAD over the rest of 2021, taking USD/CAD to 1.27 by the end of this year.”
“Gains in the price of oil lately have done little to limit CAD depreciation. Markets might be sharing our view that OPEC+ will eventually reach a deal on paring back previous production cuts. A more general softening of commodities prices in the next year as supplies catch up to the recent demand surge would also put pressure on the CAD.”
“The BoC showed where its thinking lies in its updated ToTEM III model of the economy, which places more emphasis on the impact of rate hikes on highly indebted Canadian households. Add that conclusion to the fact that Canada will close its output gap later than the US, and therefore see more muted inflation, and the BoC is set to raise rates after the Fed, and require a shallower trajectory of hikes even if the final neutral rate destination is similar to the US. Interest rate hikes have only half the impact on American households than they are estimated to have on their Canadian counterparts. As a result, look for the CAD to continue to lose its luster through 2022 on more aggressive policy action from the Fed.”