The policy moves made by central banks on rate increase are having an impact on the performance of major currencies, with the unexpected hawkish Fed announcement Wednesday giving the greenback a lift, while its stance and the Bank of Canada’s decision to hold on a rate increase the same day had a relatively modest impact on the loonie in relation to the performance of its G10 peers. The weakest performers — the euro, yen and Swiss franc — seem at a disadvantage as their respective central banks maintain ultra-accommodative policy for the foreseeable future. The Fed’s hawkish signals also caused US Treasury yields to rise and the S&P 500 to lose ground. Despite supply challenges and inflation pressures, TSX earnings per shares, which are expected to rise 11% in the fourth quarter of 2021, could reach a record high of C$356 this year, led by resources.
Scotiabank analysts and economists weigh in on how economic indicators and trends are influencing currencies, equities and bonds right now.
Foreign Exchange
The US dollar rose to its strongest level since June 2020 this week on a US Dollar Index (DXY) basis on the back of a hawkish Fed that teed up a March hike, with the additional support from risk-off sentiment in markets. At its policy announcement on Wednesday, the US Federal Reserve sounded an optimistic tone on the economy and pointed to elevated inflation and tight labour markets as justification to kick off its hiking cycle soon. Powell’s comments in the post-decision presser clarified that the Fed is targeting a March liftoff. He also suggested the bank may increase rates by more than four times this year, and possibly deploy a 50-basis-points (bps) hike in one meeting.
Among the weakest performers over the week were unsurprisingly the euro and the Swiss franc (CHF), with the yen (JPY) also posting a hefty decline. Their respective central banks look set to maintain ultra-accommodative policy for the foreseeable future that place these currencies at a disadvantage against the higher-yielding USD. Losses may have been steeper for the CHF and JPY were it not for the risk-averse tone in markets amid Russia-Ukraine tensions and global equity markets retreating to their weakest level since autumn.
While the Fed exceeded hawkish expectations, the Bank of Canada (BoC) let markets, a number of economists, and us down in leaving its overnight rate unchanged at 0.25% on Wednesday. We had expected an increase to 0.50% owing to elevated inflation and above pre-pandemic levels of employment. What made the hold more perplexing was the optimistic tone of the statement and Governor Tiff Macklem’s face-to-face with reporters.
The impact on the Canadian dollar from a BoC hold and a hawkish Fed was relatively modest, particularly in relation to the performance of its G10 peers. Macklem has chosen to take “considerate steps” in the BoC’s tightening cycle, starting with warning markets and Canadians that a hike is coming rather than raising this week. However, the BoC remains on track to lift its policy rate soon and will likely follow this with an aggressive hiking schedule that will act to support the CAD over the next few quarters against the USD, but especially against low-yielding currencies. Our latest forecast sees 175bps in BoC hikes this year.
— Shaun Osborne, Managing Director, Chief FX Strategist, and Juan Manuel Herrera, FX Strategist
Markets
In addition to the USD gains, the Fed’s implied materially more hawkish slant resulted in a sell-off of the whole US rates complex on Wednesday. The two-year Treasury yield soared by about 13 basis points and the 10-year yield increased by almost 8 bps. The S&P500 fell about 1¾% from the start of the communications in to the close.
Markets reacted to the materially greater Fed rate hikes than were priced in fed funds futures this year. Recall that the December dot plot guided to expect three hikes this year, fed funds futures increased pricing to expect 4½ quarter-point hikes and we forecast 175 bps to a 2% upper limit. At the press conference Jerome Powell, Chair of the US Federal Reserve, ducked questions about whether hikes at consecutive meetings are on the table and whether individual rate hikes in amounts over 25 bps were possible, rather than use the questions to tamp down speculation. The Federal Open Market Committee (FOMC) explicitly referenced “it will soon be appropriate to raise the target range for the federal funds rate.” That is Fed-speak for the next meeting in March
Forecast changes signalled. Powell indicated he was inclined to raise his core Personal Consumption Expenditures (PCE) forecast by a few tenths relative to the December forecast, indicating he is more worried about inflation now than at the December meeting. He alluded to supply and semiconductor problems persisting into 2023.
Timing of the roll-off of maturing securities. Powell previously indicated the roll-off of maturing securities would begin later this year but after pulling forward rate hike guidance to March the Fed left the timing more open by just saying after liftoff. That could mean our prior assumption that maturing securities start dropping off in the fourth quarter, or it could mean as soon as the second quarter, following a hike or two. The Fed did cement plans to end net purchases of Treasuries and Mortgage-Backed Securities in March.
Balanced risks. Powell noted that there was plenty of risk both on the upside and downside. On the hawkish side he noted high inflation and the risk it could move higher than the Fed’s base case. He also flagged supply chain challenges such as in China, and briefly mentioned tensions in eastern Europe clearly as a reference to Russia-Ukraine.
Read the full report here.
— Derek Holt, Vice-President and Head of Capital Markets Economics
Equities
Commodity bull market delivers. Bay Street expects a sequential 11% jump in earnings per share (EPS) for the fourth quarter of 2021, with earnings potentially hitting a new record high of C$356. On a year-over-year basis, profits growth should continue to moderate from a peak expansion in the first quarter of 2021 (+126% YoY) toward a still-eye-popping +28% year over year. We believe that a healthy labour market, combined with soaring commodity prices and increasing profit margins could argue for a beat, especially for resources.
Supply challenges and inflation pressures remain a concern. However, companies’ pricing power in an age of pent-up demand could allow for record profit margins in the coming years. For now, the Omicron outbreak is unlikely to affect TSX Q4/21 overall earnings momentum as last-minute negative earnings revisions have been mostly circumscribed to Industrials and defensive sectors. Resource and other cyclical sectors mostly saw positive adjustments at the last minute from sell-side analysts. Profits for fiscal 2021 should hit a new all-time high of C$1,305, marking a strong 62% recovery from a depressed 2020 and exceeding the previous record high in 2019 by 23%. According to consensus, fiscal 2022 should stick to double-digit EPS growth (11%) before normalizing to 5.2% growth in 2023.
Beat or miss? Materials, Energy, and Financials could surprise on the upside, while Discretionary and Industrials could disappoint. Global Banking and Markets, Scotiabank analysts see potential beats among Materials, as Fertilizer and Lumber prices surged in Q4. Benoit Laprade notes that lumber and oriented strand board prices were meaningfully higher last quarter than had been anticipated. Moreover, strong upside revisions for Fertilizers/Chemicals (+69% quarter-over-quarter) and Base Metals (+20% Q/Q) also reflect optimism among those sub sectors, while Gold and Precious Metals appear more in-line. In the Energy space, Jason Bouvier says improving balance sheets, climbing oil prices and robust downstream demand should benefit earnings and profits in Q4/21. The potential beat in Financials could be driven by a healthy labour market that gained 287,000 jobs, strong M&A activity (+20% Q/Q) and the hot housing market activity. On the miss side, we believe rails could disappoint in Q4 and weigh on Industrials. Konark Gupta suggests that is because of weaker traffic mainly due to floods in B.C., difficult winter conditions, and Canadian grain weakness. Discretionary could also miss expectations due to the ongoing microchip shortage and potentially weak end to retail sales in December.
— Hugo Ste-Marie, Director Portfolio & Quantitative Strategy; Jean-Michel Gauthier, Associate Director, Portfolio & Quantitative Strategy; and Simone Arel, Research Associate, Global Equity Research
For Scotiabank, Global Banking and Markets Research Analyst Standards and Disclosure Policies, please visit www.gbm.scotiabank.com/disclosures.