Image © Bank of Canada

- CAD to rebound as market sentiment improves say NBC

- BoC probably won't cut rates

- Speculative positioning suggests reversal higher

The Bank of Canada - and markets in general - stand accused of being overly pessimistic about the Canadian economy's prospects by National Bank of Canada (NBC) who say an improvement in sentiment over coming months will allow the Canadian Dollar to rise into the end of 2019.

Analysts at NBC's markets division say the Bank of Canada (BoC) might be too negative in its growth forecasts for the economy, and this has in turn had a knock-on effect for market expectations on interest rates, and the valuation of the Canadian Dollar.

The BoC estimate growth of 0.3% in the first quarter, but this appears too low given the data for the quarter released so far, including monthly GDP, which has been surprisingly strong and is now tracking +0.6% annualised.

The BoC’s estimates for the second quarter is at 1.3%, but this “also seems to be on the low side in our view,” says Stéfane Marion, an analyst at NBC.

The market’s consensus expectation is for the BoC to cut interest rates in 2019 as a result of their economic projections, and this has weighed on the Canadian Dollar of late given currencies tend to fall when their central banks enter a period of interest rate cuts.

Lower interest rates tend to detract foreign investors from placing their capital in a country and this limits inflows, weighing on demand for the currency.

NBC do not however agree with the consensus expectation and think rates will remain unchanged as growth recovers.

“But are markets getting ahead of themselves in expecting a rate cut from the Bank of Canada?” queries Marion. “If our more upbeat view of Canada’s economy pans out, markets will reconsider their expectations of a rate cut this year and hence give a lift to the Canadian Dollar.”

NBC bases its view on a combination of how oil prices are now higher and expected to remain relatively high (oil is Canada’s primary currency earner), and that U.S. imports of Canadian merchandise are in general experiencing a rebound.

The state of Alberta’s self-imposed oil production cuts in 2018 were intended to drive up ‘barrel-scraping’ Canadian Select crude prices but “hammered” growth, these mandated cuts are now set to be reversed, however, because oil in general and Canadian crude, in particular, has risen.

“The BoC’s estimate of 1.3% for Q2 also seems to be on the low side in our view. That’s because oil production, whose mandated cuts hammered growth last quarter, is reportedly returning to normal. Moreover, Canada stands to benefit from stronger U.S. imports in the second quarter after the Q1 purge stateside,” says Marion.

A further factor that could benefit the currency is the heavily skewed speculative short position on the Loonie, which is normally taken as a contrarian sign the opposite is going to happen and positions will soon reverse, with traders accumulating long positions instead.

“Any appreciation could potentially be amplified by the reversal of speculative net short positions on the currency. Our end-of-2019 forecast for USD/CAD is unchanged at 1.30,” says Marion.

A further factor supporting the outlook for the currency is the “fact that foreign investors continue to see value in Canadian securities. And that despite the persistence of soft GDP growth in Q1. Net foreign purchases have indeed bounced back this year after last December’s divestment,” says Marion.

NBC expect USD/CAD to fall from its current position in the 1.34s to 1.30 by end of 2019.

Their forecast for GBP/CAD, meanwhile, is for it to decline to 1.69 by the end of the year, from roughly 1.74 currently.

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