News & analysis

We have maintained a constructive view on the loonie for some time now. In our previous round of forecasts back in October, we adjusted our near-term view to factor in US election risks and our view that the dollar would bounce on the basis of a swift result providing constitutional clarity.

This hasn’t played out and the loonie’s strength continued in November as it continually tested the $1.30 level and cracked a fresh two-year high at the end of the month. With the US election reaching a practical conclusion in the eyes of the markets, barring the Senate race that awaits the results of the Georgia run-offs in January, we take this opportunity to revise our near-term forecasts for USDCAD and outline our views for 2021.

While USDCAD has broken below the 1.30 level on multiple occasions over the last month, we remain cautious in factoring in a structural rally in the loonie beyond the 1.30 level towards the year-end. We take this view based on the recent deterioration in the economic outlook over the near-term and the Bank of Canada’s likely distaste for a stronger currency. Canada’s second wave has resulted in most provinces imposing tighter containment measures to a varying degree, which will only weigh further on the economic recovery. In this environment, the Bank of Canada are likely to keep a close eye on the loonie’s level, especially after taking the rare step of referencing the currency’s value back in October’s policy statement. The likelihood of verbal intervention by the BoC has acted as a headwind for the loonie’s rally, especially as it threatens to appreciate beyond recent multi-year highs. Should USDCAD continue to sit below 1.30 and the loonie show signs of strengthening further, we expect the Bank of Canada to verbally intervene in December’s meeting. While active fiscal stimulus in Canada offset some of the headwinds that the CAD rally faces, we don’t see the headwinds completely abating until a vaccine is signaled to be widely available. We don’t anticipate this to occur until the first half of 2021, resulting it us holding a 1.30 call for 2020 year-end.

Our USDCAD forecasts for 2021 are substantially more bullish on CAD, however, as we envisage a structural rally in the loonie as risk appetite improves upon the release of an effective vaccine.

The imminent accessibility of a vaccine in 21H1 isn’t necessarily required for our USDCAD forecasts to be realised. News of an effective vaccine that will be widely available in the first half of 2021 should be sufficient for the broad risk rally to occur, resulting in USDCAD trading down to the 1.25 level in Q2. The significant rally penciled in for the first half of 2021 is due to a constructive confluence of factors that are in play to deliver a quick economic recovery in Canada relative to its peers. These include; a robust housing markets, active and aggressive fiscal stimulus plans, elevated levels of household saving in 2020 that could result in a wave of pent up demand being released once the economy reopens, and the highest amount of pre-purchased vaccine doses per capita globally.

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The arrival of a second wave in Canada has forced most provinces to introduce containment measures, following Quebec and Ontario’s lead in October. Cases in Quebec and Ontario have been rising since September. This led to targeted restrictions being implemented in Montreal and Quebec City since October 1st, with Ottawa and Toronto implementing similar localised restrictions as of October 10th. These measures are yet to be scaled back substantially, with restrictions on the high contact service sector remaining in place. While the lockdown measures in Canada’s largest two provinces, Ontario and Quebec, have seen the rate of new-cases subside somewhat, the fall in temperature continues to fuel a rise in cases nationally. Nearly 380,000 cases have been recorded in Canada at the time of writing, with over 6,000 new cases being reported daily. Over 40,000 cases were reported in the last week of November alone.


Canada’s second wave shows no signs of flattening despite provinces tightening lockdown measures

Source: Government of Canada

The second wave increases the risk of Canada’s economy recording a double dip contraction in 2020…

The Bank of Canada already projected a stagnation in the economic recovery with growth expected at 0.2% QoQ in Q4, but the second wave has become substantially more aggressive since, suggesting another quarter of negative growth is likely. A contraction in the Canadian economy again in Q4 due to the imposition of lockdown measures and another decline in consumption may even spill over into 21Q1 without the availability of a vaccine or a reduction in the number of new cases allowing lockdown measures to be scaled back.

The deterioration in near-term economic outlook since October won’t be ignored by the Bank of Canada in its December 9th meeting, especially with the loonie trading near or at two-year highs.

Back in October, the BoC made a rare reference to the strength of the loonie in its policy statement, which added a layer of resistance to the subsequent CAD rally in November. A reversion by the BoC back to verbally intervening in currency markets like that seen back in Q1 under Governor Poloz is highly likely in the short-run as the Bank looks to aid the economy through the effects of the second wave. Beyond verbal intervention, we don’t expect the Bank to alter policy in response to the near-term deterioration in 2020 given that policy was already tweaked back in October. During this meeting the Bank downgraded its economic forecasts, recalibrated the APP from C$5bn weekly to C$4bn while also extending the average maturity, provided forward guidance on interest rates by saying they will be kept low until 2023, and reduced the neutral rate of interest by 50bps to 1.75-2.75%.

We regard the changes to the asset purchase program as the most significant given that QE is their marginal tool.

By reducing their minimum purchases and targeting them towards longer-dated bonds in order to achieve the same bang for their buck, the Bank of Canada provided longevity to its QE programme. The signal of longevity meant the market took the action as marginally dovish, despite the ostensibly hawkish decision to wind down the minimum pace of purchases. With more space in the Bank’s QE programme created by this move, any jawboning by the central bank in order to weaken the loonie in December’s meeting could be reinforced by Governor Macklem highlighting that these commitments are “minimum” purchases. In effect, the BoC could ramp up its purchases towards the year-end in order to offset the recent near-term deterioration in the economic outlook and thus weaken the loonie back above the 1.30 handle.


The BoC’s balance sheet shows signs of marginal expansion as T-Bill roll-off continues to offset purchases, but the pace of bond purchases could be lifted again to offset the effects of the second wave and recent CAD appreciation

Source: Bank of Canada



A combination of extensive fiscal stimulus, prolonged monetary support, elevated orders of potential vaccinations per capita, a robust housing market and substantial levels of precautionary savings holds Canada’s economic recovery in good stead for 2021. While the risks to this outlook are mainly centered around the efficacy of the vaccines currently undergoing clinical trials and their approval by the relevant authorities, it is widely believed that an effective vaccination will be readily available in the first half of 2021. In this environment, we believe the Bank of Canada’s 4% average growth assumption for 2021 is conservative, with growth likely to be closer to 5%. Under this scenario, the conditions will be ripe for the Canadian dollar to strengthen on a more structural basis as domestic headwinds abate, especially given our view of broad USD weakness in 2021.

The availability of a vaccination isn’t necessarily required in Q1 for the Canadian economy to resume its recovery. We agree with the central bank that growth in 2021 will likely be backloaded, as the distribution of a vaccine is likely to take time before economies fully reopen. The containment of the second wave by Q1, coupled with warming temperatures should be sufficient for the Canadian economy to recover from what is likely to be another quarter of contraction in Q4. Beyond Q1, with more vaccinations pre-ordered than any other nation globally, the prospect of mass immunisation resulting in a broad reopening of the economy bodes well for Canada’s economic recovery.


Canada has the highest proportion of pre-ordered vaccines per capita which bodes well for rapid vaccination upon approval

Upon reopening, Canada’s economy is likely to experience a substantial release in pent up demand. Fiscal stimulus has effectively sheltered Canadian household finances from the effects of the pandemic, which is most visible in the unfaltering rise in house prices nationally, despite the 5.5% contraction in the economy in 2020. With household finances protected on the whole, precautionary saving has ramped. According to Statistics Canada’s reports, household savings rates climbed as high as 27.5% in Q2 before moderating back to an elevated 14.6%. It is safe to assume that some of this household saving will be released once the economy reopens in 2021, providing an additional tailwind to the economic recovery. In the Q3 Canadian Survey of Consumer Expectations for example, 8% of respondents said they will spend most of the savings generated in 2020 within the next two years, with a further 43% opting to partially pay down debts and maintain a stock of savings. In this dynamic lies a risk, however. The longer the economic outlook remains clouded with uncertainty, namely due to the absence of a vaccine, the more likely a high savings rate will remain a headwind to the economic recovery.


Canadian household savings rates peaked at a record 27.5% in Q2 before moderating to an elevated 14.6% in Q3. The release of pent up demand may add a further tailwind to the 2021 economic recovery

In combination with the above, the fall economic statement outlined by Finance Minister Freeland also outlined an active fiscal stance from the Federal government in the coming fiscal year. With this fiscal year’s deficit being revised up from 15.7% to 17.5% – and the possibility of a further increase to 18% by the end of FY21 – the Federal government expanded its stimulus spending by C$150bn over the next three years.  C$50bn of the additional stimulus package will be operational over the next two years with immediate effect, with the package led by an enhanced wage subsidy for businesses and the Highly Affected Sectors Credit Availability Program. While the remaining C$100bn will be operational once the pandemic is over, focusing on investing in key pledges outlined in Trudeau’s September throne speech. This fiscal windfall is another positive for the 2021 economic outlook and beyond for Canada, as the longer-term investments filter through the economy. We don’t expect the deterioration in the government’s finances to be of a concern until the recovery is well underway and the Bank of Canada begins to withdraw support in bond markets – likely in 2022. However, this concern will be raised in 2021 under the scenario that an effective vaccine isn’t readily available in 21H1.


Our base case assumption of broad USD weakness amid a global economic recovery in 2021, combined with a robust economic recovery domestically bodes well for the Canadian dollar in the New Year. A global economic recovery will not only aid risk appetite, thus benefitting the high beta currencies like CAD, but also allow oil markets to recover – although supply conditions will likely prevent WTI returning to pre-pandemic levels of $65 in 2021. This dynamic would provide a double-barreled boost for the loonie to take a leg higher on a fundamental level. Positive growth differentials relative to G10 peers may also play a part.

We put a subjective limit on the CAD rally at around the 1.24 level. While the Bank of Canada are unlikely to stand in the way of the loonie’s surge in 2021, a pivot by them to an average inflation target (AIT) – similar to that embarked upon by the Fed – could put an upper limit on the CAD rally.

We expect this to be a much more likely shift in the Bank of Canada’s policy framework, given the low level of inflation expectations, than yield curve control or a dual mandate.

The risk to this view is that the Bank of Canada doesn’t explicitly change its framework once the five-year review is completed in 2021, but instead embarks upon it in practice. While this would still cap the overall loonie rally as expectations of policy normalisation are pushed back, an implicit AIT wouldn’t be as big of a dovish shift in the reaction function. This would in effect create a more muted buffer than an explicit shift towards a similar framework to the Federal Reserves.

Inflation is the main constraint for the Bank of Canada moving forward. A return of demand-pull forces, boosted by fiscal “guardrails” announced in the Fall statement, along with favourable base effects, would reduce their ability to push back the normalisation cycle. While pointing to the negative output gap and labour market slack will work in the interim, an explicit shift towards an average inflation target would allow the Bank’s stimulus to be in effect for a longer period of time.


Inflation breakevens in Canada are more suppressed than in the US, begging the question “will the BoC join the Fed in moving to an average inflation target?”


Author: Simon Harvey, FX Market Analyst



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