Signals from the Bank of Canada that interest rates could increase sooner rather than later are holding the loonie firm, but with no fresh highs, against the greenback. With no signs of policy tightening in Europe or Japan, the Canadian dollar also looks poised for additional gains on the euro and the yen. Retailers and goods producers are increasingly looking for unique ways to minimize their environmental impact, recognizing consumers are choosing to buy from companies they deem to be good corporate citizens. Meanwhile, supply chain issues will continue to influence inflation and in turn assets: equities should continue to outperform bonds, and the TSX appears well positioned to outperform the S&P 500.
Scotiabank analysts weigh in on how economic indicators and trends are influencing currencies, retail and equities right now.
- The Canadian dollar retains a strong undertone following the latest Bank of Canada (BoC) policy decision. While the BoC tapered its asset purchase program again and will now operate only to maintain current levels of stimulus, rather than adding to it, policymakers suggested a heightened degree of concern about inflation and hinted that interest rate hikes might come earlier than previously suggested. Markets had expected some rebuff to quite aggressive pricing for interest rate increases that had accumulated in the past couple of weeks. Instead, the Bank of Canada seemed to endorse these moves, which accelerated further as a result.
- Markets are now pricing in nearly 125 basis points (bps) of Canadian tightening over the coming year and a policy spread over the US Federal Reserve of about 100 bps. If realized, this would be the widest policy spread between the BoC and the Fed since the financial crisis. Short-term bond spreads have widened dramatically in the CAD’s favour, with the US-Canada two-year cash bond yield differentials gapping out to 60 bps, the biggest yield advantage for the CAD since 2014. The CAD has firmed but has not made fresh highs against the US dollar. We think that is about right for now. Expectations for rate increases in the early part of next year may be overshooting; rather, a mid-year lift off for rates seems more likely, according to Bank of Canada guidance. We continue to target a 1.22 rate for USDCAD into the end of this year, however, and look for USDCAD to base around 1.20 in 2022. A move below that point cannot be excluded but we think several factors would have to coalesce (a weaker USD, higher commodity prices, as well as the BoC delivering on rate expectations) to achieve it.
- We think the CAD crosses offer better value for CAD bulls. Monetary policy in North America is clearly moving toward policy tightening but that remains an unlikely prospect in much of Europe and Japan. The CAD has made strong gains against a weak yen in the recent past and looks poised to extend higher toward 95-100 in the coming months. EURCAD is pressuring major support at 1.4265 which, if broken, would indicate scope for additional CAD gains toward 1.35/1.36 in the medium term.
— Shaun Osborne, Managing Director, Chief FX Strategist, and Juan Manuel Herrera, FX Strategist
- ESG practices are gaining prominence not only for consideration in making investment decisions, but also importantly as priority areas of focus in corporate boardrooms. While companies have developed relevant ESG (Environmental, Social and Governance) strategies and are making great strides, they are also recognizing customers have a view on these initiatives and are increasingly looking to align consumption with companies they deem to be good corporate citizens. Further, most companies are learning that good ESG practices can also be good for business and enhance profit and loss (P&L).
- Different industries impact the environment differently. There is no one-size-fits-all formula for evaluating companies’ efforts toward improved ESG. Strategies and progress instead must be viewed through an industry-specific lens. What constitutes the right approach for one company is not necessarily appropriate for another. For example, in the food retail sector, several large grocers have at their core a very strong emphasis on controlling food waste. Much progress has been made on diverting tons of food from the waste stream. A focus on food waste, though, is not a relevant focus area for most others and therefore can’t be held up as a measurement metric.
- Retailers are adapting operating models and their supply chain to minimize the environmental impact of products (packaging, sourcing, and localization), while trying to determine ways in which materials can be put back into use (plastics, traceable raw materials, and provenance on foodstuffs). This includes the emergence of circular economy models. Retailers are taking different approaches to circular retail, from retail partnerships to popups to charitable relationships. While this focus on circular models is only just emerging, we anticipate seeing such approaches move to the forefront in the years to come.
- Recycling and reusing. Most clothes in North America are thrown out after only seven to 10 wears. As a result, a new textiles economy is evolving that includes the rise of rental models, the most well-known of these being Rent the Runway, and making resale more attractive. Earlier this month, Lululemon (not covered) announced rethink, revive, and rediscover Lululemon through a trade-in and resale program that directly reinvests profits to support additional sustainability. Swedish furniture giant Ikea has made two shifts in its operating model to support enhanced sustainability. The first was to get into the home solar storage market by selling consumers solar panels in-store. The second was to launch a furniture rental service. The company is also rethinking product design so that, by 2030, every product it makes will be designed to be reused, repaired, upgraded or recycled.
— Patricia Baker, Director, Retailing, Global Equity Research
- Shortages and demand. Businesses spent the past few decades perfecting the art of inventory management techniques, i.e., integrating and coordinating with suppliers around the world to optimize (read minimize) inventory levels. The result is that lean inventories have been rapidly depleted as the re-opening of the economy has led to a surge in demand, while hiccups in the global supply chain have prevented needed restocking, leading to shortages.
- Takeaways for asset mix. It will take time to get back to normal and rebuild inventory levels. Supply chain issues will likely extend well into 2022, but we might already be going through the worst of it. Re-opening pent-up demand, supply chain issues, rising commodity prices and accelerating wage growth support our view that price pressures are not so transitory as some central banks want us to believe. While we think 5% plus inflation won’t last, inflation could remain in the 3% plus range for quite some time. From an asset mix standpoint, we see two major takeaways: despite strong gains, equities should continue to outperform bonds, and the TSX still appears well positioned to outperform the S&P 500.
— Hugo Ste-Marie, Director Portfolio & Quantitative Strategy; Jean-Michel Gauthier, Associate Director, Portfolio & Quantitative Strategy; and Simone Arel, Research Associate, Global Equity Research
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