The Canadian economy has followed a slow and uneven growth path since the oil shock and we expect only a modest acceleration of economic growth in 2017. However, we believe the economy continues to face significant headwinds, and we expect firms more linked to foreign demand to be the most prone to downside risks. We identify the following risk factors to Canadian companies.
First and foremost are competitiveness issues. We expect export oriented firms which have lost global market share over the past decade to continue to struggle in light of low productivity and high wages relative to trade competitors. Corporate tax reform proposals in the U.S. will further lower Canadian competitiveness and lower incentives to expand and invest outside of the U.S. Finally, the currency remains overvalued in our view while past depreciation is overstated as other exchange rates have seen similar rates of depreciation.
The second headwind is the rise of trade protectionism. While the anticipated reopening of NAFTA is unlikely to impose tariffs on Canadian products and instead focus on local content rules, buy American rhetoric may weigh on business activity going forward. The proposed border adjustment tax in the U.S. will likely make it more costly for U.S. firms to import Canadian products and reduce Canada's terms of trade.
Finally, the Fed tightening cycle, which we expect to continue this year with the fed raising rates by at least 50bps by the end of 2017, is likely to lead to a further rise in Canadian rates, with risk for a more pronounced increase, thereby raising domestic borrowing costs and negatively impacting investment decisions.
"The proposed border adjustment tax in the U.S. will likely make it more costly for U.S. firms to import Canadian products and reduce Canada's terms of trade."
We look for the Canadian dollar to weaken this year. We expect USDCAD to resume its path upward, finishing the year at 1.35 and peaking at 1.40. The main driver is wider interest rate differentials between the U.S. and Canada, as the Fed is expected to raise interest rates while the Bank of Canada keeps policy on hold. One way to hedge against this risk are currency forwards, which are binding contracts that lock in an exchange rate for the purchase or sale of a currency on a future date and is priced by equalizing the returns across rate differentials. Thanks for your time.
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Brittany Baumann is a Macro Strategist for the Rates and Foreign Exchange Research group at TD Securities based in Toronto. With a focus on the US and Canada, she provides research and analysis of the global economy and financial markets for the trading floor and a wide range of institutional, corporate, and commercial clients.
Prior to joining TD Securities in July 2016, Brittany worked as an economist and FX strategist at Crédit Agricole CIB in New York. In that role she was responsible for providing macroeconomic and financial market research and analysis for the US and Canada.
Brittany holds a PhD in Economics from Boston University and a BA in Economics from Georgetown University.