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Losses in commodity prices, and in particular a retreat in oil prices amid OPEC+ infighting, saw the loonie perform markedly below its peers. The CAD continues to be significantly undervalued relative to fundamental values that suggest the USDCAD should be around 1.18. While there is pent-up demand for vehicles in Canada and the US, auto sales remain slow due to lack of inventory, and production isn’t expected to accelerate until August. Meanwhile, US Treasury bonds are being weighed down by US Congress’s inaction on the debt ceiling, which is having somewhat of a destabilizing effect on markets.

Scotiabank analysts and economists weigh in on what the pandemic means for currencies, auto sales , and bond prices.

Foreign Exchange

  • Markets traded with a risk-off tone throughout the week as the US dollar notched gains against all non-haven commodity currencies. The USD’s appeal as a protection against risk was exacerbated by losses in commodity prices that saw currencies such as the Canadian dollar (CAD), Australian dollar (AUD), and the Norwegian krone (NOK) markedly underperform their major peers.
  • The CAD hit its weakest level since April 21 near 1.26 on a USDCAD basis as crude oil prices retreated amid OPEC+ infighting. Cartel members failed to reach an agreement on supply levels next month as the United Arab Emirates sought to increase its output allowance and resisted the others’ call to extend supply cuts until the end of 2022. Other commodities and equity markets traded on edge owing to the risks to the inflation and growth outlook posed by the spread of the Delta variant.
  • We think the CAD remains significantly undervalued relative to fundamental drivers (commodities and yield differentials against the US) that suggest USDCAD should trade close to the 1.18 level. Next week’s main event for the Canadian currency will be the Bank of Canada’s policy decision and Monetary Policy Report on Wednesday. We expect the BoC to announce another reduction in its pace of asset purchases as the economy emerges strongly from the latest lockdowns thanks to a fast vaccination campaign.

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

Automotive

  • Canadian auto sales posted a weak rebound in June as a result of low inventory even as some provincial economies began reopening. DesRosiers Automotive Consultants Inc. estimates 163,000 vehicles were sold — a 4% increase from last year but 12% off from June 2019 sales. On a seasonally adjusted rate (saar) basis, sales posted a 13% increase from May, when most of the country was under lockdown, but the selling rate stood at a modest 1.65 million saar units.
  • Vehicle production stabilized in June, but it is only expected to start accelerating in August, according to Wards Automotive Group. Rapid progress on vaccine roll-out in Canada should accelerate both confidence and consumption, provided there is product to purchase. In our baseline forecast, we expect production to accelerate over the third and fourth quarters. Pent-up demand for new vehicles should unwind progressively to finish the year at 1.75 million units, however uncertainty remains around supply constraints, and competition from the US for limited vehicles.
  • US auto sales for June were dampened by low inventory brought on by the semiconductor chip shortage, with a sharp retrenchment of 10% m/m (sa) in June, following robust sales in early spring. Year-over-year sales were up by 18%, but, more informatively, the selling rate stood at just 15.4 million saar units. April and May sales were running hotter than our annual forecast as stimulus cheques spurred demand that kept second quarter sales in positive territory with a 1% seasonally adjusted quarter-over-quarter improvement, following the 5% q/q uptick in the first quarter. Inventory remains at record-lows (with an inventory-to-sales ratio hovering around 1). This will impact sales in the near term with our baseline forecasting a third-quarter decline of 8% q/q before rebounding by 2% m/m (sa) in the fourth quarter to finish the year at 16.4 million units.

           —      Rebekah Young, Director, Fiscal & Provincial Economics

Bonds

  • What’s driving bonds? Things appear to be heating up for bonds again in North America, as US Treasuries began to fall mid-week, before recovering some of the lost ground on Friday. The 10-year T note was down 4–5bps on Wednesday, at 1.30% and appears to be poised to end the week at about 1.35%, which is still almost 0.4% lower than the peak in late March/early April. There are various plausible theories for this trend but the strongest argument is that there continues to be far too much liquidity pumping into markets and that’s expected to continue doing so in relation to looming debt scarcity around when the US debt ceiling gets reinstated at month-end. That issue may also have the potential to complicate the Fed taper dialogue as it did in September 2013 when the Fed held off tapering because of similar issues that led to a government shutdown. Bills auctions are going to be slashed in preparation.
  • There is a material risk of a partial government shutdown and payments prioritization by Treasury as flagged for some time now. That scenario would again demonstrate to the world the massive dysfunction that dominates American politics and its destabilizing effects on world markets. The country’s role as a reserve currency, however, would perversely have the probable effect of driving Treasury yields lower, again as in the 2013 episode. There’s no optimism around settling any of these issues anytime soon given the ongoing deep divisions in US politics, but when it eventually settles, we could see a massive cheapening trade for Treasuries with an expedited push toward Fed tapering. 
  • Congress holds the keys to fixing this problem. Its inaction on the debt ceiling is already having a very distorting and destabilizing effect on markets while the Fed is simply buying too much. The Fed has other tools at its disposal if it’s uncomfortable with the speed and magnitude of adjustment and distortions in fixed income markets, but they are band-aids when the durable solution lies with Congress. 
           —      Derek Holt, Vice-President and Head of Capital Markets Economics

 

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