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Economics

Global Markets Insights: Loonie on the rise, equities rally, but oil struggles

September 4, 2020

 

 

The loonie is on the rise, on the back of data showing that the Canadian economy is posting a solid post-lockdown rebound due to a better handling of the outbreak and solid federal employment and income support. The CAD appreciated to just below the 1.30 mark per USD briefly to reach its strongest mark since the turn of the year, despite crude prices reaching a four-week low. While the US oil industry saw numerous platform evacuations and production shut-ins due to Hurricane Laura, Western Canadian oil producers’ destination infrastructure have been spared the worst of the storm. Still, according to Alberta’s latest fiscal update, the fallout of the pandemic is expected to be record or near-record economic contractions, job losses, budget deficits and debt loads across the net oil-producing provinces this year. Meanwhile, equity prices have been on a stunning summer rally, with the S&P 500 gaining 13% and the TSX rising 6.4%, mostly due to a small group of large stocks.

 

Scotiabank analysts and economists weigh in on the latest in foreign exchange, equities and commodities.

 

Foreign Exchange

 

The USD’s weakening trend upon a reduction in its yield and growth advantage continued over the past two weeks, reinforced by Fed Chairman Powell’s comments last week suggesting policy rates will remain low for (much) longer as the bank alters its monetary policy framework. Upon crossing key levels, however, profit-taking has lifted the USD against the key currencies, at least for the moment, after touching at its lowest point since mid-2018 on Tuesday. Setting aside Friday’s US employment report, which may motivate gains for the USD upon improving economic prospects at home, we look for range-trading to take over in the near-term; though the USD-negative momentum suggests the dollar may find it difficult to make up much ground soon.

 

We are entering a time of the calendar year when seasonal trends tend to benefit the greenback, a factor that may be accentuated this year with about two months to go until the November presidential election. Markets may now begin to place more attention on the state of the presidential race. The overwhelming majority of polls and election models give Joe Biden a comfortable lead over Trump at the national level, but we may see this gap narrow as we get closer to November and thus build some fear into markets of a contested result; particularly a narrow loss by the incumbent.

 

The CAD appreciated to just below the 1.30 mark per USD briefly to reach its strongest mark since the turn of the year before moving into a narrow trading band between 1.30 and 1.31 roughly, resisting to an important degree the widespread USD gains through mid-week. The CAD’s stability is also in spite of crude oil prices touching a four-week low. Official statistics and high-frequency data suggest the Canadian economy is posting a solid post-lockdown rebound, to the benefit of the CAD, thanks to a better handling of the outbreak and solid federal employment and income support. CAD traders will now look toward next Wednesday’s Bank of Canada policy decision, in which the bank is not expected to alter its policy levers but may tee up a change to its inflation-targeting framework (in line with the Fed).

 

—  Shaun Osborne, Managing Director, Chief FX Strategist, and Juan Manuel Herrera, FX Strategist

 

Equities

 

The summer rally in equity prices has been outstanding, with the S&P 500 gaining 13% and the TSX rising 6.4%. Despite the run, we continue to see value beneath the surface. So far, the push to a new all-time high is mostly due to a small group of large stocks. However, we believe laggards have more catch-up potential if the macro healing process continues as we expect.

 

During his Jackson Hole speech last week, Federal Reserve                  Chairman Jerome Powell tweaked the Fed’s inflation policy targeting in way that could let inflation run above the 2% objective for some time even if the economy and job market are improving. While the tweak appears minor, it will lead to an even more dovish Fed, in our opinion.

 

To keep it simple: If activity/employment remains soft, the Fed will continue to press ahead with even more easing. If activity picks up, it will be slow to respond (at least until inflation comfortably exceeds 2%). Given the current slack in the economy and a double-digit unemployment rate, it could be quite some time before labour markets could be considered too strong and inflation exceeds 2% in a way that would force the Fed to move.

 

It seems that there is no end in sight to monetary support, which will offer a strong backstop for risk assets. This does not mean equities can’t undergo an interim pullback, but it does suggest that weakness should be bought.

 

Tactical Asset Mix: Beta Indicator Still Favors Cyclicals (CYC) over Defensive (DEF). Our equity signal remains overweight with the allocation to stocks rising to 72.5% (neutral at 60%, range of +/- 20%). All three categories of indicators underpinning our equity signal (macro, fundamentals, and technicals) remain supportive for now. Interestingly, if we divide our equity recommendation (72.5%) by our neutral weight (60%), we could get a sort of beta indicator. The “beta” indicator correlates well with the relative performance of high beta to low volatility stocks and Discretionary versus Staples. The beta indicator is suggesting a CYC over DEF bias in portfolios.

 

 —  Hugo Ste-Marie, Director Portfolio & Quantitative Strategy; Jean-Michel Gauthier, Associate Director, Portfolio & Quantitative Strategy; and Simone Arel, Research Associate, Global Equity Research

 

Commodities

 

Copper prices cleared the 3 USD/lb threshold in August for the first time since 2018 and are now more than 40% higher than the nadir reached in late March. Chinese demand continued to drive the industrial metals complex higher, as reflected in a number of reports of surging metals imports that are naturally invoking comparisons to the post-Global Financial Crisis commodities boom.

 

For gold, the key development in August was the Federal Reserve’s shift in tone. The US central bank’s apparent tolerance for inflation above the traditional 2% target, alongside already low interest rates — at least for now — are being interpreted by markets as potentially softer US real rates over the medium-term. However, this effect might unwind over the longer-run as implementation is put to the test.

 

Oil industry headlines were dominated of late by Hurricane Laura, whose top wind speed of 150 mph put it among the strongest storms on record in the US. As firms braced for storm surges and gale force winds, the USGC saw numerous platform evacuations and production shut-ins. Those supply reductions nudged WTI above 43 USD/bbl late last week, with price gains limited by ongoing fears of demand-side weakness related to COVID-19.

 

Western Canadian oil producers will be breathing a sigh of relief with refinery infrastructure at their marginal barrels’ primary destination looking to have been spared the worst of the storm. The WCS benchmark held steady in August, while its discount to WTI widened to the 11–12 USD/bbl range. Spot prices remain below pre-pandemic heights, but their differential to WTI has been unsustainably narrow this year as a result of temporary excess egress capacity and reduced Venezuelan heavy oil output.

 

Alberta’s first fiscal update since COVID-19 reached Canadian shores allows for further stock-taking on the pandemic’s oil and gas sector impact. Record or near-record economic contractions, job losses, budget deficits and debt loads are now expected across the net oil-producing provinces this year. Alberta will also incur further costs associated with its crude-by-rail program — contracts for which have now been sold to the private sector — with weaker pricing and this year’s narrowing of the WCS-WTI discount eroding related revenues. Also of note, Alberta anticipates that even after a strong growth bounce-back next year, real GDP will sit more than 6% below its 2014 peak, which would extend the downturn that began in 2015 to at least eight years.

 

The WTO statement that the US Department of Commerce erred in 2017 when it imposed countervailing duties on Canadian softwood lumber exports was the latest chapter in a multi-decade cross-border spat. The US is the primary destination of Canada’s softwood lumber exports, and contends that its neighbour’s stumpage fees constitute a de facto subsidy system that justifies the use of countervailing duties. Policy changes are uncertain, but the decision has nonetheless been cheered by Canadian producers following the US’s move to restore aluminum import tariffs.

To read the full Scotiabank Commodity Price Index report from Scotiabank Economics, click here.

 

—  Marc Desormeaux, Senior Economist

 

For Scotiabank, Global Banking and Markets Research Analyst Standards and Disclosure Policies, please visit www.gbm.scotiabank.com/disclosures.

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