Despite a handful of vaccines being approved globally, COVID-19 will continue to weigh on retailers’ performance for the first half of 2021. There are several factors dampening spending, including more restrictions brought on by rising case numbers and deaths, further business closures, and job losses. In the US, expectations that the new Democrat administration will bring in more stimulus, along with higher deficits, will give rise to an increase in 10-year bond rates and give the USD a lift, though gains in the currency aren’t likely to be significant or sustained. A broad rally in commodity prices and higher oil prices lifted the CAD to its highest since early 2018, and close to fair value.
Scotiabank analysts weigh in on what the pandemic means for retail, equities and foreign exchange.
Optimism tempered by rise in COVID-19 cases. The year began with a wave of optimism as various COVID-19 vaccines were approved across the globe and health authorities began to deliver them. The vaccine news is leading businesses to begin to plan for a return to more normal operations in the not-too-distant future. This is all happening alongside rising cases and deaths, clearly underscoring that efforts to date have not curbed the spread and COVID-19 remains a clear and present danger, as well as a deterrent for consumers looking to get back to normal. In Canada and elsewhere, new restrictions are being enforced, with Quebec citizens subject to a curfew and Ontario declaring a new state of emergency this week. These measures are putting added strains on retailers and will impact operating performance for the first half of 2021, forcing some businesses to close amid a second round of tighter restrictions.
Job losses will curtail spending. Consumers are entering 2021 with more cash as spending on commuting, entertainment, hospitality and travel was curtailed by pandemic lockdowns. At the same time, large numbers of households have faced and will face job losses. Recent weeks have seen a large spate of announced layoffs starting with the airline industry but not stopping there. The unemployment rate in Canada is now at 8.5%. While that level is down substantially from a peak of 13.7% in May, it remains worrisome. These job losses will no doubt impact the economy and dampen spending in certain segments, again pressuring retail.
Uncertainty makes planning difficult. One particular aspect of the new lockdowns that is troublesome for business is the fact it has become increasingly difficult to plan for the coming year. The uncertainty associated with not knowing when businesses can be open makes it extremely difficult to not only forecast but also manage a workforce and inventory. Many retailers have embraced technology and developed digital platforms to offset the impact of closures and to deliver goods and services virtually, but in most cases this provides only a partial offset.
— Patricia Baker, Director, Retailing, Global Equity Research
US 10-year bond yields still have some upside potential. The acceleration in bond yields certainly grabbed investors’ attention last week. To be sure, US 10-year bond yields increased 20 basis points in the first week of the year to 1.12%. Still, we continue to see further upside over time. From a technical standpoint, the next major resistance level to watch stands at 1.5%. From a fundamental perspective, our model pegs the fair value of US 10Yr yields near 2.1%. That’s up from the 1.8% range a couple of months ago and is mostly attributable to the spike in the ISM manufacturing index near 60, as well as a decline/normalization in the World Economic Uncertainty index.
With the new US administration likely to press hard on the fiscal accelerator in coming quarters, deficits should continue to grow and inflation could rise, which would move our fair value even higher over time. In fact, we note that longer-term inflation expectations have already started to rise. Although a temporary macro soft patch in Q1/21 due to an uncontrolled wave of COVID cases could slow the pace, we think bond yields still have plenty of upside potential.
From an asset mix perspective, we believe government bonds have the worst outlook and possess the greatest risk of generating negative returns.
— Hugo Ste-Marie, Director Portfolio & Quantitative Strategy; Jean-Michel Gauthier, Associate Director, Portfolio & Quantitative Strategy; and Simone Arel, Research Associate, Global Equity Research
The New Year brought mixed fortunes for the USD, which continued its late 2020 descent early in January, but stabilized and improved modestly against the major currencies in the past week. The primary reason for its improved tone is the recovery in US long-term yields in response to expectations that Democrat control of the levers of government in Washington will result in more stimulus and higher US deficits. Of course, stimulus could also result in a stronger recovery and higher inflation down the road and real and nominal yields have moved in the USD’s favour in the past few days, giving it a lift.
More broadly, positioning and sentiment appear to have tilted perhaps a bit too far against the USD, providing a window for a counter-trend rebound in the currency as moderate gains force more recently established and therefore more vulnerable short USD positions to cover. As well, seasonality may be a factor in the USD rebound; the USD typically rallies somewhat in the early part of the New Year, then usually underperforming in a marked way in Q2/Q3. There is perhaps a window for the broader decline in the currency to steady in the near term, but we don’t expect gains to be significant or sustained.
The Canadian Dollar (CAD) found support from the broad rally in commodity prices in recent weeks; oil prices reached the highest since February as OPEC+ producers maintain supply discipline and investors bet on stronger growth as vaccines are (slowly) rolled out. The CAD’s gains to its highest level since early 2018 brings it close to fair value, according to our fundamental model, having spent most of last year trading well below (near one standard deviation, by our measure) equilibrium. We expect USDCAD to consolidate in the short run, which might see some corrective USD gains develop towards the 1.2850-1.2950 range in the coming weeks. We remain bullish on the CAD outlook over the remainder of 2021, however. Our January forecast update sees USDCAD ending 2021 at 1.23.
— Shaun Osborne, Managing Director, Chief FX Strategist, and Juan Manuel Herrera, FX Strategist
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