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Canadian dollar could plunge to 72.5¢ on NAFTA 'crash-out'

Briefing highlights

  • How NAFTA collapse could hit loonie
  • RBC quarterly profit climbs 12 per cent
  • Markets at a glance
  • Pound gains on Brexit divorce outline
  • LSE chief quits
  • Bitcoin tops $11,000

Analysts say the death of NAFTA would send the Canadian dollar reeling.

Now, JPMorgan Chase has put a number on it: As low as 72.5 cents (U.S.).

This comes amid the mounting threat of North American free-trade agreement talks collapsing. There has been clear antagonism at the bargaining table, with the Trump administration saying it wants a fair deal and Canada and Mexico warning some demands are unacceptable.

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All of which has prompted analysts to begin looking at what Canada could look like in a post-NAFTA world.

JPMorgan still believes the threat of collapse is low at this point, but nonetheless has calculated the fallout.

"The obvious worst-case NAFTA scenario is a 'crash-out' where negotiation impasses cannot be overcome and the U.S. decides to initiate formal exit from the trade pact via a six-month notification," said JPMorgan's Daniel Hui.

"Any NAFTA collapse, even if there is a relatively benign fallback to the [old Canada-U.S. free trade pact], would be a significant near-term disruptive shock to Canada activity given the large footprint of U.S. and Mexican trade and the impact it would have on North American supply chains," he added in the bank's 2018 currency outlook.

Here's what Mr. Hui's crash-out scenario looks like:

The Bank of Canada, having raised its benchmark overnight rate twice this year, could "unwind" those quarter-of-a-percentage-point increases and possibly cut even deeper "to cushion the blow of uncertainty and trade disruption."

Add to that the potential short-term weakness in the price of West Texas intermediate crude, the U.S. benchmark, say to $35 a barrel, on fears of a "broader global trade slowdown."

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Along with that could come a "de-pricing" of how fast the Federal Reserve raises rates because of the potential hit to the U.S. economy.

With all that in mind, said Mr. Hui, "a reasonable expectation might be USD/CAD rising to 1.34 to 1.38."

Referring to the U.S. versus the Canadian dollar, he means a loonie as low as between 72.5 cents and about 74.5 cents.

"Thereafter, USD/CAD would be more path-dependent on what the fallback looks like, and how quickly firms would be able to adjust to the new cross-border regulatory and tariff regime," Mr. Hui added.

Many currency analysts expect a weak loonie for some time yet, anyway, largely because of the assumed different rate paths of the Fed and the Bank of Canada, which has signalled a pause after the two hikes.

A Canadian central bank moving slower than its American counterpart would not be loonie-friendly.

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Analysts also believe NAFTA rhetoric is going to escalate, further troubling the currency market.

"NAFTA negotiations are seeing little progress, with revised U.S. negotiating objectives released [earlier in November] suggesting little movement towards compromise on a number of contentious issues, including local-content requirements," said Toronto-Dominion Bank senior economist Brian DePratto.

"At this point, it seems safe to assume that the process will not be completed by the spring 2018 target, prolonging uncertainty."

A crash-out aside, JPMorgan's Mr. Hui projected the Canadian dollar will be at just about 77 cents in the first quarter of 2018.

"This is driven by Fed tightening and overall U.S. cyclical optimism as U.S. tax reform efforts push towards the finish line," he said.

"Meanwhile, NAFTA uncertainty may intensify in the first few months of the year as negotiations push towards some resolution ahead of Mexican elections, especially if parties resort to brinkmanship."

Mr. Hui further forecast, though, that the loonie will perk up to about 82.5 cents by the end of next year "as NAFTA risks fade … U.S. cyclical optimism comes off the boil, and, in particular as we approach the end of the year, fading willingness to price in further Fed hikes relative to BoC."

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RBC profit up

Royal Bank of Canada posted a 12-per-cent jump in fourth-quarter profit, boasting of a "great year" that ended with record profit of $11.5-billion.

Fourth-quarter profit climbed to $2.8-billion, or $1.88 a share, diluted, as annual profit rose to $7.56 a share.

Chief executive officer Dave McKay called it a "great year" with a "disciplined approach to risk management" and a speed-up in digital investment.

"On a first cut, it looks like a low quality beat," said analyst John Aiken of Barclays, citing better-than-expected provisions, among other things.

"We have seen the market shake off negative prints from RY before, but we would be surprised if the market did not look past the reported number on this occasion," he added, referring to RBC by its stock symbol.

"While there was some strong underlying growth (loans and margins in domestic retail as well as [assets under management] growth in wealth management), it did not translate to earnings as investments continue to fuel expense growth."

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Even North Korea seemingly cannot derail the current bullish sentiment

Joshua Mahony, IG

Markets at a glance

The pound jumped as Britain and the European Union agreed to the framework of a divorce that could cost the U.K. somewhere around €55-billion.

"It is a hefty price tag, but it will allow both sides to start the post-Brexit trade negotiations off on the right foot," said London Capital Group senior market analyst Ipek Ozkardeskaya.

Read more


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