CIBC's Monthly FX Outlook; On Both CAD and USD

The US dollar rose against its major trading partners early Friday before a lighter schedule that begins with the University of Michigan's final consumer sentiment reading for April at 10:00 am ET.

The Kansas City Federal Reserve is expected to release its monthly services reading for April at 11:00 am ET and the St. Louis Fed is expected to update its gross domestic product growth Nowcast estimate for Q1 for the final time around midday.

A quick summary of foreign exchange activity heading into Friday:

fell to 1.1353 from 1.1385 at the Thursday US close and 1.1389 at the same time Thursday morning. There are no Eurozone data on Friday's schedule. The next European Central Bank meeting is scheduled for June 4-5.

fell to 1.3308 from 1.3338 at the Thursday US close and 1.3315 at the same time Thursday morning. UK retail sales growth slowed in March from February, but the year-over-year rates accelerated, according to data released overnight. The next Bank of England meeting is scheduled for May 8.

rose to 143.4028 from 142.6670 at the Thursday US close and 142.3508 at the same time Thursday morning. Tokyo consumer price growth, an early indicator of Japan's consumer price index, accelerated in April according to data released overnight. The next Bank of Japan meeting is scheduled for April 30-May 1.

rose to 1.3884 from 1.3856 at the Thursday US close and 1.3843 at the same time Thursday morning. Canadian retail sales data for February and manufacturing sales for March are due to be released at 8:30 am ET, followed by the Canadian budget balance for February at 11:00 am ET. The next Bank of Canada meeting is scheduled for June 4.

Canada's retail sales data later could come in weaker than expected, potentially weakening the Canadian dollar, Monex Europe analysts say in a note. The February retail sales data coincided with an escalation in U.S.-Canada trade tensions and the end of the goods and services tax holiday so risks are skewed towards a weaker reading, they say. This could dent the Canadian dollar's recent strength, leaving it trading at levels "better reflective of our view on the headwinds facing the Canadian economy." The data are due at 1230 GMT and are expected to show a 0.4% fall in sales in February, according to a WSJ survey of economists. The U.S. dollar rises 0.2% to 1.3889 Canadian dollars. (renae.dyer@wsj.com)

The Canadian dollar (CAD or loonie) is back to following the US dollar (USD) more closely after Canada got exempted from the so-called 'Liberation Day' tariffs of President Donald Trump on April 2, said ING.

Despite existing trade barriers between the United States and Canada, markets have re-established the rationale that Canadian growth is a close function of U.S. growth, and outflows from U.S. assets are more likely to land in Europe than in neighboring Canada, wrote the bank in a note.

The consequence of this relinking of North American currencies is that observed volatility has been significantly lower compared with other major currencies since April, noted ING.

Market expectations are for an increase in CAD volatility around the election results, stated the bank. The directional impact will be determined by expected implications for U.S.-Canada trade relationships, Canada's fiscal position and what this all means for the Bank of Canada.

A Conservative win would be a surprise for markets, and ING thinks CAD would rally on the view that Trump may be more lenient in trade negotiations towards another conservative leader. Mark Carney's short tenure as prime minister so far has brought diplomatic interests closer to Europe, which may be perceived as an obstacle to trade negotiations with the U.S.

In terms of fiscal plans, the impact may be perceived more in the bond market, and spill over into foreign exchange only in case of major bond volatility, pointed out the bank. While it is true that Liberals plan a wider deficit, markets may deem the Conservatives' spending cuts — and by extension, the smaller deficit projections — as too optimistic.

While larger tax cuts by the Conservatives can lift CAD by limiting the Bank of Canada's ability to cut rates, the risks of an adverse Canadian bond reaction could offset the benefits for the loonie, added ING.

To sum up, the bank thinks that a Liberal majority win is largely priced in and will have a limited short-term impact on CAD. The implications for the longer term depend more on the U.S. administration than on the new Canadian government, which should remain open to renegotiating trade agreements with the U.S. regardless of the election result.

A Liberal minority government — likely with the NDP and/or the Greens — should trigger some CAD weakness as the government would be seen as less stable. ING believes that should be "moderate" in size though.

Should the Conservatives surprisingly win the election, the bank expects a rally in CAD in hopes of an earlier de-escalation in Canada-U.S. trade tensions, although there is an outside risk of negative spillover from excessive volatility in Canadian bonds.

ING's projections currently embed a Liberal majority government as a baseline assumption. The bank estimates the pair to trade at 1.39 at the end of Q2 and face some upside pressure in Q3 before starting a more structural downtrend from Q4.

Morgan Stanley doesn't expect the Canadian parliamentary election on Monday to have huge implications for given how front and center the United States policy outlook is at the moment for foreign exchange investors.

However, the bank thinks that a likely Liberal-led government will be more Canadian dollar (CAD or loonie) positive than a Conservative-led government, especially if the Liberals attain an outright majority.

Morgan Stanley believes markets will perceive policies from the Liberal Party as more growth-positive than a

Conservative-led government through fewer immigration curbs and a looser fiscal stance

than under the Conservatives.

Fiscal spending tends to be positive for exchange rates when it 1) improves long-term growth prospects and 2) doesn't raise any debt sustainability concerns. In other words, additional fiscal spending that has a high fiscal multiplier and increases the likelihood of raising the potential growth of an economy would likely be CAD positive as long as it doesn't mean investors conclude that the fiscal trajectory is looking increasingly unsustainable, stated the bank.

Fiscal plans from the Liberal Party point to more spending than planned under the Fall Economic Statement (FES). Tax cuts and canceling the capital gains tax are some of the costly measures, but the overall focus of the rest of the fiscal plan is to shift the fiscal path towards capital investment, with an aim to incentivize private sector investment and to raise productivity.

This type of spending should be CAD-positive over the longer term, Morgna Stanley thinks, given some of the divergent trends in private investment and productivity between the United States and Canada.

More fiscal spending than envisioned during the FES may also keep rate expectations more supported as investors likely reduce the likelihood of significant more Bank of Canada easing in case of a looser fiscal stance, it pointed out.

The fiscal plans released by the Liberal Party also indicate its willingness to provide support to the economy from tariff-induced growth risks. Fiscal policy providing such support may be seen by investors as an alternative to further BoC cuts, which may also lead to investors reducing their expectations of more BoC cuts, which should be CAD positive.

Canada's fiscal situation has deteriorated in recent years relative to the 2000s and 2010s.

However, compared with other G10 economies, it's evident that Canada has more fiscal room to spend, if the bank looks at relatively simple metrics such as projected deficits and debt levels. As a consequence, Morgan Stanley doesn't think that the negative fiscal sustainability-exchange rate relationship often evident in emerging market currencies currently applies to CAD.

The bank believes that global macro themes will likely be a more important driver. CAD should underperform European currencies in this environment as elevated U.S. policy uncertainty should weigh on global risk sentiment and growth expectations.

is likely to decline as the bank sees the DXY weakening — in part due to the unpredictability and volatility of U.S. policies, leading investors to demand a risk premium to hold U.S. assets.

The US dollar rose against its major trading partners early Thursday ahead of a full schedule of data releases.

Weekly initial jobless claims, and durable goods orders and the Chicago Federal Reserve's national index, both for March, are all due to be released at 8:30 am ET.

Existing home sales data for March are scheduled to be released at 10:00 am ET, followed by weekly natural gas stocks inventories at 10:30 am ET.

The Kansas City Fed is expected to release its manufacturing reading for April at 11:00 am ET and the Atlanta Fed is due to update its gross domestic product growth Nowcast estimate around midday.

A quick summary of foreign exchange activity heading into Thursday:

rose to 1.1389 from 1.1327 at the Wednesday US close but was below a level of 1.1404 at the same time Wednesday morning. There are no Eurozone data on Thursday's schedule, but European Central Bank policy board member Philip Lane is due to speak at 9:00 am ET. The next European Central Bank meeting is scheduled for June 4-5.

rose to 1.3305 from 1.3266 at Wednesday US close and 1.3302 at the same time Wednesday morning. UK car registrations rebounded in March after a decline in the previous month, while UK manufacturing expectations remained pessimistic in April. The next Bank of England meeting is scheduled for May 8.

fell to 142.5085 from 143.4256 at the Wednesday US close but was above a level of 141.9988 at the same time Wednesday morning. Japanese corporate services price growth accelerated in March according to data released overnight. The next Bank of Japan meeting is scheduled for April 30-May 1.

fell to 1.3855 from 1.3886 at the Wednesday US close but was above a level of 1.3823 at the same time Wednesday morning. Canadian average weekly earnings for February are due to be released at 8:30 am ET. The next Bank of Canada meeting is scheduled for June 4.

The Canadian dollar has suffered much less than any other G10 currency from the US dollar rebound since Monday, when it had instead remained flat despite widespread rallies against the US dollar, said ING.

Since U.S. President Donald Trump's so-called "Liberation Day" at the start of April, the loonie and USD have re-linked, wrote the bank in a note to clients.

This used to be the norm before Trump's attack on Canada with tariff threats started late last year, stated ING. The ongoing re-linking has probably been a consequence of Canada being spared the April 2 reciprocal tariffs, which allowed markets to default to trading the loonie as an extension of U.S. growth sentiment — a key driver of Canadian activity — and as such being highly correlated with the USD again.

observed volatility has been significantly lower than other G10 currencies since "Liberation Day" — confirming the relinking — but the one-week at-the-money volatility is trading at around 1.30 to one-week historical volatility, pointed out the bank. That is unusual for before Canadian federal elections, meaning that markets are attaching a greater foreign exchange risk to Monday's parliamentary election.

ING's view is that markets are probably taking hints from polls and pricing in a majority win by the Liberals and current Prime Minister Mark Carney. If that ends up being the result next week, then the CAD impact should be limited and quickly overshadowed by borrowed USD volatility.