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Bullish and bearish scenarios as Canadian dollar now ‘more vulnerable to NAFTA crunch time’

Briefing highlights

  • Why the loonie is ‘vulnerable’
  • Markets at a glance
  • Trump comments ripple through markets
  • Aimia accepts sweetened Aeroplan bid
  • Quote of the day

Loonie ‘more vulnerable’

JPMorgan Chase believes the Canadian dollar is now “more vulnerable to NAFTA crunch time," given its recent gains.

There are bullish and bearish scenarios for the loonie laid out in a recent report by Daniel Hui of the big Wall Street bank, but at this point he expects the currency to hover at about 77 US cents or lower before rising again next year.

“This is based off of expectations for stable rate-spreads [and] elevated NAFTA risks throughout much of the remainder of 2018 (at least through U.S. mid-term elections),” Mr. Hui said, his comments coming as talks to overhaul the North American free-trade agreement continue.

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“As NAFTA eventually gets resolved [in the first half of 2019], this should unleash a stronger investment outlook and hence more upside for more BoC hikes and hence CAD strength,” he added, referring to the Bank of Canada and the loonie.

There's a lot at play that muddies the waters, including NAFTA and a Trump administration probe on whether to slap hefty import duties on auto imports, a move that would hammer the Ontario economy and make the recent steel and aluminum levies pale in comparison.

"On the one hand, a swift [NAFTA] agreement and resolution would restore a sense of security for business investment outlook and may also entail the removal of steel and aluminum tariffs, which together could spur a knee-jerk in CAD’s favour," Mr. Hui said.

"On the other hand, we remain wary of a further deterioration in the U.S.-Canada negotiating relationship. In particular, we remain cognizant of the ongoing Section 232 investigation for auto tariffs, which should conclude in coming weeks."

Shaun Osborne, Bank of Nova Scotia’s chief foreign-exchange strategist, and his colleague, strategist Eric Theoret, believe recent economic indicators are still being “underplayed,” which affects currency markets.

"The economy is humming along, and we think economic trends in Canada are supportive of our idea that the BoC has more tightening to do this year (two hikes) than the market is currently pricing in (one 25-basis-point move)," Mr. Osborne and Mr. Theoret said in a report, though they noted "headwinds," such as lower commodities prices and the discount of Western Canada Select crude to the U.S. benchmark price.

“These developments render the longer-run terms-of-trade boost to the CAD that we referred to recently a little less compelling,” they added.

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“However, our high-frequency fair-value model still suggests that equilibrium is close to 1.29 and we think the USD should head back towards that area over the course of the coming week.”

By 1.29, they meant a Canadian dollar worth 77.5 US cents.

JPMorgan's Mr. Hui also cited bearish scenarios for the loonie: NAFTA talks "turn south," those stronger indicators of late "turn out to be a flash in the pan," and local oil prices ease even more.

And the bullish: The Bank of Canada sees recent indicators as “signalling a much faster needed pace of rate hikes, political risks push down the U.S. dollar, and NAFTA threats ease.”

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Markets at a glance

President Donald Trump, as he oft does, is playing into today’s action.

“First, Trump’s interview with Reuters regarding his low expectations for the China talks, while a sensible position to take ahead of the talks, seems to suggest the president is happy to keep this pot boiling over for the foreseeable future, applying pressure to a Chinese government that is trying to battle tariff wars and manage a fundamental realignment of the national economy,” said IG chief market analyst Chris Beauchamp.

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“The second issue is his public criticism of the Fed - while we should be used to it by now, it has come at just the right point to unnerve the late comers to the dollar rally. Fed minutes, PMIs and Jackson Hole at the weekend mean that dollar bulls, while likely to be vindicated in the longer-term, are in for a tough few days.”

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Quote of the day

“The President would like easier monetary policy, or at least, he would not like to see interest rates marching higher to offset the boost to the economy from his fiscal and trade policies. His liking for low rates is something he has in common with Turkey’s President Erdogan, possibly because at heart, both are in the real estate business. The difference, of course, is that President Erdogan can influence monetary policy, because the [Central Bank of the Republic of Turkey] is clearly not independent; whereas President Trump can feel let down by Fed under Chair Powell, but he can’t do much about it.”

Kit Juckes, Société Générale

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