The loonie started the year strong, continuing its gains on the greenback thanks to the momentum in commodities and a rally in energy. Meanwhile, after ending 2021 at near record highs, equities, particularly Tech and Growth, are starting the year off with volatility that can’t all be blamed on Omicron. In fact, the stealth rally in bond yields since early December may explain a lot of the volatility. The auto sector’s fourth-quarter production volumes will be off substantially year-over-year, but the quarterly gains point to a gradual recovery when chips become available, though prices may be influenced by inflation and interest rates.
Scotiabank analysts weigh in on how economic indicators and trends are influencing currencies, equities and the automotive sector right now.
- Canadian dollar gets off to a good start in 2022. The CAD was among the better performing major currencies in 2021 and has started 2022 in a somewhat similar vein, gaining 0.9% against the US dollar and outpacing most of its G10 currency peers. This is a little unusual given that seasonal trends typically reflect a soft undertone in the CAD in the early part of the calendar year before trends turn more positive heading into the spring.
- The Canadian currency’s performance is rooted in three factors. One, energy prices have rallied and commodity prices broadly have regained momentum after dipping in early December. Higher commodity prices confer a positive terms-of-trade effect on the CAD. Two, the Bank of Canada is poised to tighten monetary policy; more investors are embracing the idea that interest rates are likely to move higher this year, with one Wall Street bank shifting its forecast this week to a January lift off and five rate increases in total this year. We think the Bank of Canada will tighten in March and keep pace with the US Federal Reserve, raising rates four times in 2022, but relatively tighter policy is a clear risk for Canada in 2023. Three, technical signals are CAD-bullish. The USD rallied to test 1.2950+ levels in late December — the top of the range over the past year — and the failure to progress points to a retest of the broader range base near 1.23. This week’s break under 1.2610 support reaffirms the 1.23 zone as the technical target for USDCAD, in our opinion.
- While we are bullish on the CAD outlook, we remain selectively constructive on the USD elsewhere. The USD has traded poorly so far this year, despite clear warnings from Fed policy-makers that tighter monetary policy is coming soon and that a reduction in the Fed’s balance sheet may commence in the foreseeable future. This should be supportive for the USD against those currencies whose central banks — the euro, yen and Swiss franc in particular — are likely to maintain very accommodative monetary policy settings this year.
— Shaun Osborne, Managing Director, Chief FX Strategist, and Juan Manuel Herrera, FX Strategist
- "Growth" malaise entering 2022. While equities ended 2021 at or near record highs, the first few days of 2022 have been more volatile, especially for Tech and Growth equities. As of Jan. 6, the S&P 500 Technology sector was already down 3.7% year to date, the Nasdaq was off 3.6%, and the MSCI USA Growth index was down 4.2%. To put things in perspective, the S&P 500 equal-weight index was only down 0.4%.
- Don’t blame Omicron. The emergence of the Omicron variant has monopolized investor attention in recent weeks, which makes it easy to blame the selloff on further COVID uncertainty. Still, the stealth rally in bond yields since early December explains current equity market volatility much better, in our view.
- Investment implications of rising yields:
- Investment styles. As we indicated several times last year, rising bond yields should negatively impact the Growth trade. Hence, it is no surprise to see Tech and Growth trade reeling.
- Asset mix. More pain to come for bondholders. We believe there’s more damage to be done this year as bond yields rise further. Cash remains far from compelling.
- Sector allocation. The relative performance of US Financials, Energy, Industrials, and Materials tends to track changes in bond yields.
— Hugo Ste-Marie, Director Portfolio & Quantitative Strategy; Jean-Michel Gauthier, Associate Director, Portfolio & Quantitative Strategy; and Simone Arel, Research Associate, Global Equity Research
- Fourth-quarter production volumes for autos will be down significantly year-over-year, however, there appears to be meaningful improvement quarter-over-quarter as some automakers (including GM and Ford) have spoken about improved semiconductor availability. Production volumes in 2021 were significantly constrained by supply chain challenges – most notably, semiconductor shortages. Moreover, it is our understanding that sudden changes to production schedules have become less frequent, which should also help the cost side of the equation in Q4, relative to Q3.
- We are anticipating that higher consumer demand coupled with record low inventory levels will support a sustained period of robust production volumes when chip availability allows, and as a result we have increased our near-term North American production volume assumptions. We continue to anticipate a gradual recovery in industry volumes through 2022 as chip availability improves, and a full recovery in 2023.
- There are other macro considerations at play in the sector. The Omicron variant will almost certainly have an impact on production, staffing levels, etc. in the first quarter of 2022; however, we expect any impact to be short-lived. While commodity prices (i.e., steel, aluminum, and resins) have come off peak, inflationary pressures such as employee wages and energy prices (specifically in Europe) could have an effect, with the consumers required to absorb the higher costs. Also, if the suppliers are required to absorb some of the inflation, will they be able to offset with labour and efficiency gains or will margins come under pressure? Interest rates are headed higher, which leads us to question whether this will impact the make/size of a vehicle purchase as borrowing costs rise. At some higher level of rates, the broader impact on the economy could result in a lower level of vehicle sales, but we think that’s someway off.
— Mark Neville, Director, Equity Research, and Tosin Jaiyeola, Research Associate
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