Is the market too bearish on the loonie?

Is the market being too bearish about the loonie's prospects this year?

The market may have become too bearish on Canada’s dollar, say economists at National Bank Financial.

Loonie bears have been in abundance at the moment as Canada’s economy continues to weaken this year, weighed down by low oil prices, bad weather and an extended slump in the mining industry. Expectations that the Bank of Canada will cut its benchmark interest rate even further this season have also ben a headwind.

But a dark tone may have become too gloomy and the Canadian dollar might be setting up to surprise the market this year.

“The Canadian dollar could show more resilience than several other major currencies when confronted with headwinds generated by a strengthening USD,” said economists at NBF.

Their prediction is based on the current outlook for rate cuts in the Bank of Canada. Most of the market is pricing inside a second rate cut this year, following a surprise decline in January to 0.75% from 1%. But NBF sees the opportunity of the BoC to carry rates this season.

“In our view, the BoC pause could include next year, taking into consideration the repeated signals from Governor Stephen Poloz who seems to be ‘increasingly comfortable’ with the amount of easing in financial conditions through the surprise January rate cut,” the economists said. “It will take a lot more bad news to persuade the Governor to alter his stance since he already expects Q1 GDP to be ‘atrocious.\’”

If the financial institution does pause on rates throughout the year, the current wave of loonie bearishness could ease somewhat.

“When the BoC refrains from cutting the overnight rate again, the C$ could appreciate a little and trend more in line with the terms of trade,” NBF economists said.

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