Currency markets appear to be in the summer doldrums, perhaps exacerbating the decline of the US dollar, which saw its biggest three-day drop since the early days of the pandemic. However, it is likely that rising US interest rates, geo-political risks and persistent equity market volatility will keep the USD stronger for longer against its major currency peers, taking the wind out of any previously expected strengthening in the loonie. Meanwhile, as apartment vacancy rates drop, Canadian apartment Real Estate Investment Trusts are trading low. The overall energy environment has remained strong through the second quarter and into the third, although there is greater than normal variability on both the up and downside.

Scotiabank analysts weigh in on how economic indicators and trends are influencing currencies, utilities and energy and REITs right now.

Foreign Exchange

  • Foreign Exchange markets have something of the summer doldrums about them, at least in terms of participation as client activity remains light. Despite that, the US dollar experienced its biggest three-day drop since the early days of the pandemic in 2020. Low volumes may actually have exacerbated that decline after last week’s higher than expected US Consumer Price Index report seemingly failed to shift Federal Reserve policymakers’ thinking away from the 75 basis-point rate hike (toward a 100bps increase) that swaps have priced in for the July 27 Federal Open Market Committee meeting. 
  • Regardless of its short-term performance, we adjusted our USD forecasts to reflect the likelihood that rising US interest rates, geo-political risks and persistent equity market volatility will keep the dollar on a “stronger for longer” run against its major currency peers. We have been anticipating a strengthening in the Canadian dollar to reflect a resilient economy, a hawkish central bank and rising commodity prices but the sort of appreciation we were looking for over the balance of the year looks unrealistic. Our broader outlook remains consistent with some CAD gains over the medium to longer term, but we now look for USDCAD to end the year at 1.27 and retain our 1.23 forecast for the end of 2023. CAD gains will have to await until equity market volatility — one of the currency’s biggest headwinds at the moment — abates later this year. 
  • We adjusted other G10 currency forecasts to reflect sustained USD strength and other idiosyncratic risks facing major currencies in the coming months. While the European Central Bank looks poised to join the global central bank tightening wave this week, growth prospects remain highly uncertain while the war in Ukraine continues and Russia threatens to throttle natural gas supplies to European markets. We expect EURUSD to edge below par in the coming months if this threat develops. The yen may edge toward 1.40 as US yields rise and the Bank of Japan maintains its easy policy stance, meanwhile. We recognize that USD gains are looking stretched from a longer-term point of view, but USD bears will have to be patient until USD-negative catalysts gain more prominence. 

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

Real Estate and Real Estate Investment Trusts (REITs)

  • Apartment REITs are the second-worst trading asset class in the sector despite having some of the best NTM NAVPU (net asset value per unit) growth. Most of the Canadian Apartment REITs are seeing above-average growth and below-average valuation. We can’t remember the last time Apartment REITs as a whole were trading so low (26% average NAV discount). We’ve fielded lots of investor questions on identifying “defensive laggards” in the space (i.e., REITs with operationally defensive characteristics if we embark on an economic slowdown but have underperformed year-to-date) and we think Apartment REITs fit the bill nicely. Granted, we’re fully aware of the primary driver of underperformance (regulatory risk in our view) but we think the risk-reward looks appealing.
  • Rental vacancy is down. Urbanation Inc., which provides information and analysis on the condominium market, released its Greater Toronto Area (GTA) Rental Report for the second quarter, which for the first time combined condo and rental residential data. Rental vacancy fell 40 basis points in the quarter and 370bp year over year to 1.4%, near the 1% pre-pandemic level. Tight availability, resulting from strong demand and limited supply, drove 5.9% condo rent growth in the quarter, compared with 3.1% in the first quarter. Condo rent growth was 16.7% y/y. The Urbanization research shows that for the fifth consecutive quarter, demand outstripped supply. Interestingly, less than 25% of purpose-built rental units (built post 2005) offered incentives versus 45%q/q and 88% y/y.
  • Elevated regulatory risk is preventing unit prices from reflecting improved fundamentals, in our view. Our best guess is for clarification as part of the federal government’s Fall Economic Statement, typically released in November. Recently, we felt the 2023 Allowable Guideline Increase for lease renewals in Ontario at 2.5% was a small step toward some stabilization.

— Mario Saric, Managing Director, Real Estate & REITs Equity Research

Canadian Utilities & Energy Infrastructure

  • The overall energy environment remained strong through the second quarter of 2022 and into Q3, which presented select opportunities to increase estimates over the past few weeks. That said, global macro headwinds and uncertainty have resulted in valuation compression for the group and share price declines — although less than the broader market. Looking at Q2 results, overall we are in-line with the consensus. However, we see greater than normal variability on both the upside and downside.
  • Resilient earnings estimates. While we largely maintain our earnings estimates heading into the reporting season, we have seen some sizable upward revisions in recent weeks, including for Keyera Corp. (KEY), TransAlta Corp. (TA), and Capital Power Corp. (CPX), aided by a robust Alberta power price environment. As well, given strong Ontario demand, we assume Hydro One Ltd. (H) should have a good quarter and our estimates are ahead of consensus.
  • In our view, more energy-exposed midstream and pipeline group are well positioned in this strong energy price environment. We recently hosted a number of pipeline, midstream, and oil and gas producers in Calgary where the management teams highlighted various tailwinds they are seeing, which are supportive of future earnings growth.

— Robert Hope, Director, Energy Infrastructure and Justin Strong, Associate Director, Renewable Energy and Clean Fuels

 

Company Specific Disclosures: Hydro One Limited (H-T)

Scotia Capital (USA) Inc. or its affiliates has managed or co-managed a public offering in the past 12 months. Scotia Capital (USA) Inc. or its affiliates has received compensation for investment banking services in the past 12 months. The Bank of Nova Scotia and its affiliates collectively have a net long position in excess of 0.5% of the total issued share capital of the issuer. Within the last 12 months, Scotia Capital Inc. and/or its affiliates have undertaken an underwriting liability with respect to equity or debt securities of, or have provided advice for a fee with respect to, this issuer.

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