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Canadian Dollar Outlook: More Weakness Expected as Expectations for BoC Quantitative Easing Grow

- BoC tipped to introduce quantitative easing
- Move would follow strong action at U.S. Fed
- Oil to also be a drag on CAD

Bank of Canada

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The Canadian Dollar is being tipped to experience further weakness by analysts at a global investment bank, who say the near-50% slump in oil prices and likelihood of further action at the Bank of Canada are two reasons to retain a bearish slant on the currency.

The Canadian Dollar was seen trading lower against the Pound, Canadian Dollar and Euro on the same day the U.S Federal Reserve threw everything it had left in its arsenal at fighting the coronavirus-inspired market and economic meltdowns.

The Fed announced it would engage in a programme of unlimited quantitative easing, thereby abandoning a $700BN cap it had previously set. The move by the Fed essentially floods global markets with much-needed Dollar liquidity and will go a long way in easing the pain inspired by the recent market meltdown.

What the Fed does has an indirect bearing on the Canadian Dollar as most economists expect the Bank of Canada (BoC) to mimic the Fed, therefore expectations will have risen on Monday for a big-ticket programme of quantitative easing to come out of Canada in the near future.

The foreign exchange textbook suggests that when a central bank engages in a programme of quantitative easing the currency it issues falls in value owing to the huge increase in supply of that currency into the market.

"The notion that the BoC is piggybacking the Fed in dealing with the Covid-19 crisis may provide additional steam to USD/CAD as markets may start to price in BoC QE," says Chris Turner Global Head of Markets and Regional Head of Research for UK & CEE at ING. "We are starting to see 1.50 in USD/CAD as a feasible target now, although that may represent the top of the range for the pair."

The U.S. Dollar-to-Canadian Dollar exchange rate is quoted at 1.4405 at the time of writing, some 0.74% higher than where it started the day.

The Pound-to-Canadian Dollar exchange rate is quoted at 1.6813, up 1% on where markets opened on Sunday.

Ian Pollick, a fixed income strategist at CIBC Capital Markets says the actions at the U.S. Fed now open the door to similar schemes coming out of Canada.

"Together, the Fed and the Treasury have introduced up to USD$300.0bn in new financing aimed at supporting the flow of credit to employers, consumers and businesses. In concert, we see this morning’s announcement as a very important step in alleviating building pressures in select parts of the fixed-income and funding markets, which should have a positive spillover into similar markets in Canada. Given the steps taken today, it is only a matter of time until we see something ‘similar’ announced in Canada," says Pollick.

Beyond central bank issues, an additional consideration for the Canadian Dollar going forward will be oil market dynamics.

The price of oil has almost halved in March alone, amidst a sharp decline in demand owing to the coronavirus global slowdown and a price war between Russia and Saudi Arabia that has meant OPEC has effectively abandoned any attempts at supporting oil prices, for the time being at least.

For the Canadian Dollar, which derives significant value from Canada's oil exports, the fall in oil prices will add as a drag for the foreseeable future.

"Oil remains a big element of uncertainty as the rebound on Thursday was quickly erased in late-week trading and the outlook remains quite grim," says Turner. "Barring a rebound to pre-OPEC+ breakup price levels – that hardly seems to be feasible now – hard times are likely ahead for the Canadian energy sector (which makes up 12% of GDP) and this will inevitably be a constant drag on CAD ahead, regardless of daily noise in the oil market."

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Decisive Fed Action

The Dollar was seen trading lower against a number of currencies on Monday, March 23 following the announcement of a raft of initiatives by the U.S. Federal Reserve to support the U.S. economy, of which the headline measure was the introduction of an unlimited programme of quantitative easing.

The Dollar retreated and global stock markets recovered after the Fed all but abandoned its self-imposed limit of $700BN in asset purchases under its quantitative easing programme and said it would pump as much money as was required into the economy.

The Fed will now begin conducting open-ended quantitative easing - as the Bank of Japan currently does - in the Treasury and MBS market in, "amounts needed to support smooth market functioning and effective transmission of monetary policy".

The deluge of fresh Dollars - which come on top of other measures announced by the Fed last week - have all aided in easing the liquidity crunch in U.S. Dollars on global markets that saw the currency spike in value in the first half of last week.

The U.S. Dollar had "become the most desired monetary instrument surpassing traditional safe havens like US Treasuries and even Gold meaning that those that have it have greatly increased their bargaining power. Furthermore, the now inevitable recession is going to mean that many loss-making businesses will need cash to see them through," says Richard Windsor, an independent research analyst.

But the promise of hefty liquidity has meant the premium that was placed on the Dollar last week has now faded somewhat, hence the declines in the currency seen in the wake of the latest Fed measures.

The Dollar Index - a broad measure of overall Dollar strength against a basket of currencies - is quoted half a percent lower at 102.77. The Pound-to-Dollar exchange rate has recovered to 1.1662 having been as low as 1.1506 earlier in the day. The Euro-to-Dollar exchange rate is quoted 0.78% higher at 1.0776.

"Jerome Powell and the FOMC have finally had their “whatever it takes moment” and promised open ended asset purchases aimed at beating the U.S. yield curve and financial conditions into submission. The move makes sense based on what we know about QE, which is that the purchases need to be huge, timely, and unconditional for optimal effect. With financial conditions still in a tailspin despite last week’s global monetary bazooka volley, the Fed has decided to once again go big and go early," says Ranko Berich, Head of Market Analysis at Monex Europe.

The latest moves by the Fed confirm the world's most important central bank appears to be getting a grip on the financial turmoil suffered since markets took fright of the rapidly spreading coronavirus epidemic in late February.

"The measures are expansive and aggressive in every sense. The pace of the “QE classic” element will be a scorching $75 billion of treasuries and $50 billion of mortgage backed securities a day this week. In addition to expanded QE, the Fed has taken a host of additional measures. These include steps to allow it to purchase corporate debt, including reviving the crisis-era Term Asset-Backed Securities Loan Facility," adds Berich.

 

Fed Goes All Out

In addition to effectively making quantitative easing unlimited, the Fed went a step further today and announced the establishment of two new facilities aimed directly at the corporate bond market:

1) The Primary Market Corporate Credit Facility (PMCCF): this will be open to investment-grade companies and will provide bridge financing for a period of up to four years.

Borrowers may elect to defer their interest and principal payments for up to six months under the terms and conditions governing the PMCCF.

"In terms of mechanics, this facility will use funds from the Governments Exchange Stability Fund (ESF) of up to USD$30.0bn, and the ESF will then make equity investments in an Special Purpose Vehicle (SPV) set–up by the Fed," says CIBC's Pollick. "Think of this as a tool aimed at the primary corporate bond market."

2) The Secondary Market Corporate Credit Facility (SMCC) is aimed at the corporate bond market and will facilitate the smooth functioning of liquidity in this crucial market.

"The SMCC will directly purchase corporate bonds (investment-grade) in the secondary market and U.S.-listed ETFs. Again, using the Treasury’s ESF, the government will make an equity investment in an SPV created by the Fed," says Pollick.

The Fed also announced that they will now allow the Money Market Mutual Fund Liquidity Facility (MMLF) to include a wider range of securities, specifically including municipal variable rate demand noted (VRDNs) and bank certificates of deposit.

The Fed has also re-opened the Term Asset-Backed Securities Loan Facility (TALF), and it will enable issuance of ABS backed by student-loans, auto-loans, credit-card loans and, loans guaranteed by the Small Business Administration (SBA).

"The Fed and the Treasury have introduced up to USD$300BN in new financing aimed at supporting the flow of credit to employers, consumers and businesses. In concert, we see this morning’s announcement as a very important step in alleviating building pressures in select parts of the fixed-income and funding markets," says Pollick.

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