By Fergal Smith
TORONTO (Reuters) – Canada’s dollar, which has soared over 12 percent against its U.S. counterpart since May, will give up some of those gains in coming months as the boost from Bank of Canada interest rate hikes begins to fade, a Reuters poll found on Monday.
The loonie notched its strongest level since May 2015 on Friday at C$1.2063 after the BOC surprised some investors on Wednesday with its second rate increase in three months.
The BOC’s moves have driven Canadian bond yields above their U.S. peers for the first time in about three years, adding to the loonie’s allure.
However, the central bank is likely done raising interest rates this year, a Reuters poll of primary dealers showed on Thursday, though the central bank is seen charting a more aggressive tightening path for 2018 than had been anticipated earlier.
“Just as the Bank of Canada turned on the rate hike cycle with very short notice, they could also turn it off very quickly if the currency strengthens too much,” said Daniel Katzive, head of FX strategy North America at BNP Paribas (PA:BNPP).
The Canadian dollar was seen weakening to C$1.2300 in a month from around C$1.2160 on Monday, the median forecast in a poll of over 40 foreign exchange strategists showed.
From there, the currency is expected to soften to C$1.2400 in three months before stabilizing.
“While there is scope for further (BOC) tightening (over the coming months), we would expect that it would occur at a more gradual pace,” said Eric Viloria, senior currency strategist at Wells Fargo (NYSE:WFC).
Gains for the loonie have come despite the uncertain prospects of the future of the North American Free Trade Agreement, given that most of Canada’s exports go to the United States.
Canadian, U.S. and Mexican officials began negotiations last month to update the trade pact. However, U.S. President Donald Trump recently said he would probably need to terminate NAFTA to get what he considers a fair trade deal.
The Canadian currency has also shrugged off recent volatility in crude oil prices, one of the country’s major exports.
U.S. crude prices tumbled more than 3 percent on Friday on worries energy demand would be hit hard by Hurricane Irma, and they extended their decline early on Monday.
“In our view we are already overshooting a little bit in USD-CAD relative to what’s a long term sustainable level,” Katzive said.
His estimate of fair value for the currency is around C$1.2700.
While primary bond dealers’ prevailing view in a Reuters poll was of no more BOC rate hikes in the rest of 2017, the overnight index swap market reflects traders’ view of a nearly three-in-four chance of the central bank hiking again by December.
“We still think the Bank of Canada is going to move again later on in the year, but this one (a rate hike by December) is priced in,” said Krishen Rangasamy, senior economist at National Bank Financial.
“What’s not priced in is a Federal Reserve hike. If we are right (and the Fed hikes in December), the U.S. dollar could make a comeback later in the year or the beginning of next year,” he added.
(Polling by Anu Bararia and Sarmista Sen; Reporting by Fergal Smith; Editing by W Simon)