CAD: A BALANCED OUTLOOK CAMILLA SUTTON l CHIEF FX STRATEGIST l l

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CAD: A BALANCED OUTLOOK CAMILLA SUTTON l CHIEF FX STRATEGIST l416 866 5470 l CAMILLA.SUTTON@SCOTIABANK.

1 CAD: A BALANCED OUTLOOK CAMILLA SUTTON l CHIEF FX STRATEGIST l l CAMILLA.SUTTON@SCOTIABANK.COM APRIL 2013 DIAL IN: (local to Toronto) PASSCODE: # CONFERENCE CALL COMMANDS Press 1 Skip backward 5 seconds; Press 3 Skip forward 5 seconds Press 4 Skip backward 5 minutes; Press 6 Skip forward 5 minutes Press 5 Pause the playback

2 SCOTIABANK: FORECAST FX USD performance is mixed REAL GDP US outperforms Canada f 2014f f 2013f 2014f USDCAD US CADUSD Canada AUDUSD Mexico EURUSD Euro Zone 1.4 (0.5) (0.5) 0.9 GBPUSD UK USDJPY Japan USDCNY China INFLATION Expected to remain contained INTEREST RATES Remain accomodative US Q412 Q413 Q414 Canada FED BoC COMMODITIES Yearly averages ECB Oil (WTI) BoE Gold 1,670 1,650 1,650 BoJ RBA

3 G4 WHO WILL BEAR THE BRUNT OF CURRENCY APPRECIATION? G4 ALL WANT A WEAKER CURRENCY Who will bear the brunt of currency appreciation? This is the most important question to answer for FX in

4 2013 THIS IS A EUR, JPY & USD STORY FX RETURNS SINCE JULY DRAGHI! EUR AUD GBP CAD JPY FX RETURNS JULY 25, 2011 (DRAGHI) TO APRIL 18, 2013; normalized to 100 Source: Bloomberg, Scotiabank FX Strategy Main themes in 2013 Central bank policy & spillover effects balance sheet expansion matters. Politics: new leadership in China, a challenged US system, uncertainty in Italy, German elections. Global growth outlook. 3

5 CAD DRIVERS & OUTLOOK A BALANCED OUTLOOK USDCAD FORECAST Q4 2013: 1.02 Q4 2014: 1.00 Trend: USDCAD RANGEBOUND DRIVERS OF CAD Global growth outlook (US & China) Bank of Canada policy vs Fed policy Broad USD outlook Domestic fundamentals Housing Oil Relative growth Flow: Investment, Triple A Global risk aversion / appetite IMPACT ON CAD Short term Medium term Negative Positive Neutral Neutral Negative Negative Negative Positive Negative Positive Negative Positive Negative Neutral Neutral Positive Negative Neutral SUMMARY: NEUTRAL/NEG NEUTRAL/POS 4

ii) Overall deterioration in correlations oil & equities are negative.

6 CAD HAS STRONGEST CORRELATION WITH INTEREST RATES CAD CORRELATIONS WITH MAJOR ASSET CLASSES CORRELATION SUMMARY FOR CAD: i) Strongest correlation: interest rates. ii) Overall deterioration in correlations oil & equities are negative. iii) AUD correlation is strong and EUR correlation is rising. iv) Risk metrics, broad ones like VIX have low correlation. 5

7 CAD IS PRO CYCLICAL GLOBAL GROWTH SHIFTS LOWER, LIMITING CAD STRENGTH 6

8 CAD IS PRO CYCLICAL CAD AND COPPER BOTH IMPACTED BY GLOBAL GROWTH OUTLOOK Copper (R) CADUSD (L) Source: Bloomberg & Scotiabank FX Strategy 7

US GROWTH OUTLOOK THREE POSITIVE TRENDS HOUSING, CARS & ENERGY US

Scotiabank FX Strategy Source: Bloomberg, Scotiabank FX Strategy US

market helps to offset some of weakness.

9 US GROWTH OUTLOOK THREE POSITIVE TRENDS HOUSING, CARS & ENERGY US HOUSING STARTS ARE RISING US VEHICLE SALES Source: Bloomberg, Scotiabank FX Strategy Source: Bloomberg, Scotiabank FX Strategy US CRUDE OIL PRODUCTION (barrels) US GROWTH: Improving housing and car market helps to offset some of weakness. Energy production likely to prove long term positive for US economy. Source: Bloomberg, Scotiabank FX Strategy 8

10 THE CDN vs US ECONOMIC BACKDROPS HOUSING & EXPORTS US GROWTH: CONSUMPTION AND BUSINESS INVESTMENT LED CANADIAN GROWTH: CONSUMPTION AND BUSINESS INVESTMENT LED Inventories Net Exports Business Investment Government Residential Consumption Source: Scotiabank 1 Source: Scotiabank US GROWTH OUTLOOK: Consumption & business investment are drivers Residential expands Government contracts CDN GROWTH OUTLOOK: Consumption & business invest are drivers Residential contracts Net exports expand Government contracts 9

11 THE NORTH AMERICAN ECONOMIC BACKDROPS ARE LINKED US & CANADIAN GDPs ARE LINKED US and Canadian GDP are linked. What is good for the US is good for Canada. GROWTH: INITIALLY NEGATIVE AS CANADA UNDERPERFORMS US ULTIMATELY POSITIVE AS US RECOVERY FLOWS INTO CANADA 10

differentials are not that large Positive for some

12 GLOBAL GROWTH WHO WINS ON GROWTH STORY FROM HERE GROWTH OUTLOOK AND IMPACT ON FX Advanced economies differentials are not that large Positive for some EM Positive for CAD and USD Negative GBP Negative EUR 11

13 ADVANCED ECONOMY INFLATION & EXPECTATIONS CONTAINED DEVIATION FROM INFLATION TARGET: HEADLINE VS SIX TO TEN YEAR AHEAD INFLATION 1.5 JN CA FR US DE ES UK IT Six to ten year ahead inflation forecasts as of December 2012 (deviations from target) headline inflation (deviations from target) Source: IMF 12

14 GOLD COLLAPSE HINTS AT HURDLES AHEAD GOLD Gold falls 15% Source: Scotiabank FX Strategy & Bloomberg GOLD COLLAPSES 15% OVER TWO DAYS Cyprus potential central bank sales; sell recommendations; weak Chinese GDP; margin calls Central bank policies enough for moderate growth but no more; therefore inflation fears dissipate CAD this is negative 13

15 CENTRAL BANKS LOW GROWTH, CONTAINED INFLATION OPENS DOOR TO POLICY US Fed Policy: Chair Bernanke is dovish QE3 begins to taper late 2013 Rates on hold until mid 2015 Equates to a strong USD on a relative G4 basis BOJ Policy: Mr. Kuroda as governor is dovish Targets a doubling of monetary base; aggressive bond buying program; 2% inflation target in two years Equates to a weak JPY on a relative G4 basis BoE Policy: Mark Carney as governor, combined with views of MPC, is dovish Expect asset purchases increased beyond 375bn Expect implementation of other forms of alternative policy (communications, private asset & FLS type) Equates to weak GBP on a relative G4 basis ECB Policy: President Draghi expected is slow to shift but ultimately moves to a more dovish stance President Draghi fails to act early to cut rates; but forced to turn more dovish Equates to a weak EURUSD 14

16 CENTRAL BANKS LOW GROWTH, CONTAINED INFLATION OPENS DOOR TO POLICY LOW GROWTH & CONTAINED INFLATION OPENS DOOR TO POLICY RESPONSE Change in CB balance sheet assets relative to GDP is significant. Expected change in BoJ assets is surprising and significant. 15

THE FED: TAPERING & END OF QE BASED ON QUALITATIVE MEASURES End of QE based on qualitative measures, defined as: a substantial improvement in labour markets We define a substantial improvement as:

17 THE FED: TAPERING & END OF QE BASED ON QUALITATIVE MEASURES End of QE based on qualitative measures, defined as: a substantial improvement in labour markets We define a substantial improvement as: all labour metrics moving in right direction nonfarm payrolls close to 200k/mth for 6mths growth metrics are also important because it is labour outlook more than current situation Source: Bloomberg, Scotiabank FX Strategy 16

18 THE FED: HOW THE FED JUDGES THE LABOUR MARKET Federal Reserve Bank of Atlanta Interpreting substantial improvement Dec 2007 (Pre-recession) April 2013 Dec 2009 (Empl trough) Work part time for econ reasons Initial claims Difficult to fill (NFIB) Marginally attached workers Job finding rate Temp help services employment Payroll Unemployed Legend for fonts Utilization Leading indicators Employer behaviour Confidence Quits (JOLTS) Conference board job availability NFIB hiring plans Hires (JOLTS) Vacancies (JOLTS) Source: Federal Reserve Bank of Atlanta Leading indicators are strengthening back to pre recession levels; confidence & utilization are weak. 17

19 THE FED: HIGHER INTEREST RATES BASED ON QUANTITATIVE MEASURES Higher rates in US based on: Unemployment rate falling to 6.5% as long as inflation expectations 2 yrs out not above 2.5% and long run inflation expectations are well anchored. Fed Evans suggests 5.5% should be threshold. Source: Bloomberg, Scotiabank FX Strategy 18

20 CAD NEUTRAL: BANK OF CANADA MONETARY POLICY OUTLOOK ONE YEAR OIS MARKET SHIFTS: NO RATE HIKE PRICED IN 2013 At 1.0% market pricing in a 0% probability of an interest rate hike or cut over next 12 months Source: Scotiabank FX Strategy & Bloomberg Market prices in no interest rate hike or cut in Canada in BoC policy relative to the Fed is neutral to bullish CAD. CENTRAL BANK POLICY: NEUTRAL 19

21 CAD RISK: CANADA S HIGH HOUSEHOLD DEBT CANADA s HIGH HOUSEHOLD RELATIVE TO OTHERS Source: IMF Australia Canada Norway Sweden UK High household debt: Canada is in good company with high household debt. Spillover of global monetary policy. A problem with large housing price declines, a drop in labour income & other negative shocks. Begins to risk financial stability. 20

22 CAD RISK: HOUSING Canadian housing market: anticipate a moderate cooling not a collapse Housing market supported by: interest rates, immigration, employment & commodity prices. Interest rates: BoC on hold until 2015 Immigration: no change in trend. Employment: gains are slowing; but unemployment at 7.0% and trending lower. Commodity: stabilization at current levels. Prices cooling on government initiative. Differences between Canada & US: CMHC (mortgage insurance) Recourse loans No tax deductions for mortgage interest. CANADIAN HOUSING NEGATIVE BUT TOO MUCH BAD NEWS IS PRICED IN 21

23 CAD RISK: CANADA s TRADE PATTERN SHIFTS CANADIAN TRADE BALANCE DIVERGENCE BETWEEN ENERGY & NON ENERGY Source: IMF The deterioration in the non energy trade balance is a concern: Autos and M&E haven t recovered from 2001 recession. Forestry collapsed with US housing market. Energy trade balance increasingly important but also at risk. 22

24 CAD RISK: TRADE CANADIAN EXPORTS STALL $ Source: Bloomberg Canada s exports fail to recover. Canada s percentage of world exports is falling. Canada trades mainly with the US and other low growth economies; only 9.3% of exports go to the high growth EM. Canada s share of US imports is falling, as China s is rising. For Canada s recovery to take hold; exports need to climb. 23

25 CAD RISK: TRADE CANADA s EXPORTS (as of Q4 12 % of total) Energy products Cars & parts Metal & minerals Cdn exports (%) Comm services Consumer goods Forestry products Chem, plas & rubber M & E Farm, fishing,etc. Electronics Aircraft & other trans equip Other Source: Statistics Canada & Scotiabank FX Strategy Canadian exports are not balanced by geography or product Energy makes up 20% of total Canadian exports Cars and parts and forestry make up 20% of exports CANADIAN TRADE: OIL IS RISK; FORESTRY, AUTOS AND SERVICES ARE POSITIVE 24

26 CAD RISK: US DOMESTIC OIL PRODUCTION mboe/d US GAS AND OIL PRODUCTION FORECAST Source: OECD/IEA US moves from importing 20% of energy needs net exporter by Energy demand: China s increases 60% by 2035; India s rises by 50%; OECD rises by just 3%. 25

27 CAD RISK: US DOMESTIC OIL PRODUCTION US DOMESTIC PRODUCTION DOES NOT EQUAL LOWER CDN OIL EXPORTS US OIL IMPORTS ARE FALLING BUT NOT FROM CANADA Mn of barrels Total US oil imports US imports from Canada Source: Scotiabank FX Strategy, Bloomberg, US Department of Energy 26

28 CAD RISK: US DOMESTIC OIL PRODUCTION US DOMESTIC PRODUCTION DOES NOT EQUAL LOWER CDN OIL EXPORTS US OIL IMPORTS 2005 to 2012 Cdn imports rise at expense of Mexico, Africa & Venez 3 mils of barrels per day Canada Saudi Mexico Venez Iraq Source: EIA, Scotiabank FX Strategy Nigeria Colombia Kuwait Angola Brazil US imports from Canada are rising at the expense of Mexico, Africa & Venezuela. 27

CAD RISK: NORTH AMERICAN OIL PRICING OIL PRICE SPREADS NARROW Brent WTI Western Cdn Select Spread between Brent and Western Canadian Select Source: Scotiabank FX Strategy &

29 CAD RISK: NORTH AMERICAN OIL PRICING OIL PRICE SPREADS NARROW Brent WTI Western Cdn Select Spread between Brent and Western Canadian Select Source: Scotiabank FX Strategy & Bloomberg The Brent Western Cdn Select spread has narrowed from $65 to $25 since December. This is positive for Canada and CAD. OIL: PRICING IMPROVING BUT US DOMESTIC PRODUCTION IS RISK 28

30 CAD NEGATIVE: FLOWS US EQUITY OUTPERFORMANCE US equities are outperformed Canadian equities by significant margin. Driving US equity appeal. 29

31 CAD POSITIVE: FLOWS FOREIGN Source: Bloomberg, Scotiabank FX Strategy International securities transactions Still suggest appetite for Canadian assets by foreigners but trend is less positive. 30

32 CAD POSITIVE: FLOWS TRIPLE A MATTERS In declining universe of triple A rated assets; Canada s triple A matters. 31

CAD POSITIVE: FLOWS THE VALUE IN TRIPLE AAA Total Allocated $ (bn) change in FX reserves 175 125 75 25 (25) (75) Other USD (125) Source: IMF, Scotiabank FX Strategy 2003 2006 2009 2012 FX reserves

33 CAD POSITIVE: FLOWS THE VALUE IN TRIPLE AAA Total Allocated $ (bn) change in FX reserves (25) (75) Other USD (125) Source: IMF, Scotiabank FX Strategy FX reserves allocated to other currencies like CAD and AUD climb. FX reserve buying of other currencies almost equals new buying of USD. FLOWS: POSITIVE OF AAA OFFSET BY EQUITY UNDERPERFORMANCE & US GROWTH OUTLOOK 32

34 CAD NEUTRAL: SENTIMENT IS BEARISH BUT HAS SWUNG TOO FAR Market is bearish CAD Diverging views on CAD and AUD are rare SENTIMENT: TOO BEARISH FOR A BALANCED OUTLOOK FOR CAD 33

35 CAD DRIVERS & OUTLOOK A BALANCED OUTLOOK USDCAD FORECAST Q4 2013: 1.02 Q4 2014: 1.00 Trend: USDCAD RANGEBOUND DRIVERS OF CAD Global growth outlook (US & China) Bank of Canada policy vs Fed policy Broad USD outlook Domestic fundamentals Housing Oil Relative growth Flow: Investment, Triple A Global risk aversion / appetite IMPACT ON CAD SHORT TERM MED TERM Negative Positive Neutral Neutral Negative Negative Negative Positive Negative Positive Negative Positive Negative Neutral Neutral Positive Negative Neutral SUMMARY: NEUTRAL/NEG NEUTRAL/POS 34

36 MAJOR RISKS RISKS THAT WOULD SHIFT OUR FX FORECASTS G4 central bank policy: spillover effects. Inflation central bank policy stems significant inflationary pressures. Global growth deterioration. Oil geopolitical tensions rise dramatically; oil rallies and threatens global economy. Geopolitics 35

37 FX MARKETS DRIVEN BY CENTRAL BANK POLICY G4 ALL WANT WEAKER CURRENCIES Who will bear the brunt of currency appreciation? This is the most important question to answer for FX in

38 SCOTIABANK FX STRATEGY FX STRATEGY SUMMARY OF DOCUMENTS Daily FX Update Published at 7:45am (EST) Daily LatAM Update Published at 7:45am (EST) Daily Asian Update Published at 10:00pm (EST) Currency Sentiment CFTC Report Published every Friday Special Reports Active trade strategies; intraday market moving event, etc. FX STRATEGY JOINT PUBLICATIONS WITH ECONOMICS Global Views Weekly update across asset classes FX Monthly Review of global currencies and forecasts FX OUTLOOK CONFERENCE CALL Twenty minute update on FX strategy FX STRATEGY GLOBAL COVERAGE Camilla Sutton, CFA, CMT G10 Chief Currency Strategist (416) Sacha Tihanyi Emerging Asia Senior Currency Strategist Eduardo Suarez LatAM Senior Currency Strategist Eric Theoret G10 Currency Strategist DISCLAIMER: This report is prepared by The Bank of Nova Scotia (Scotiabank) as a resource for clients of Scotiabank. Opinions, estimates and projections contained herein are our own as of the date hereof and are subject to change without notice. The information and opinions contained herein have been compiled or arrived at from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness and neither the information nor the forecast shall be taken as a representation for which The Bank or its affiliates or any of their employees incur any responsibility. Neither Scotiabank or its affiliates accept any liability whatsoever for any loss arising from any use of this report or its contents. This report is not, and is not constructed as, an offer to sell or solicitation of any offer to buy any of the currencies referred to in this report. Scotiabank, its affiliates and/or their respective officers, directors or employees may from time to time take positions in the currencies mentioned herein as principal or agent. Directors, officers or employees of Scotiabank and its affiliates may serve as directors of corporations referred to herein. Scotiabank and/or its affiliates may have acted as financial advisor and/or underwriter for certain of the corporations mentioned herein and may have received and may receive remuneration for same. This report may include forward looking statements about the objectives and strategies of members of the Scotiabank Group. Such forward looking statements are inherently subject to uncertainties beyond the control of the members of the Scotiabank Group including but not limited to economic and financial conditions globally, regulatory development in Canada and elsewhere, technological developments and competition. The reader is cautioned that the member's actual performance could differ materially from such forward looking statements. You should note that the manner in which you implement any of strategies set out in this report may expose you to significant risk and you should carefully consider your ability to bear such risks through consultation with your legal, accounting and other advisors. Information in this report regarding services and products of Scotiabank is applicable only in jurisdictions where such services and products may lawfully be offered for sale and is void where prohibited by law. If you access this report from outside of Canada, you are responsible for compliance with local, national and international laws. Not all products and services are available across Canada or in all countries. All Scotiabank products and services are subject to the terms of applicable agreements. This research and all information, opinions and conclusions contained in it are protected by copyright. This report may not be reproduced in whole or in part, or referred to in any manner whatsoever nor may the information, opinions and conclusions contained in it be referred to without in each case the prior express consent of Scotiabank. Scotiabank is a Canadian chartered bank. TM Trademark of The Bank of Nova Scotia. Used under license, where applicable. Scotiabank, together with Global Banking and Markets, is a marketing name for the global corporate and investment banking and capital markets businesses of The Bank of Nova Scotia and certain of its affiliates in the countries where they operate, including, Scotia Capital Inc. and Scotia Capital (USA) Inc. all members of the Scotiabank Group. 37

39 APPENDIX EUR: BEARISH EURUSD FORECAST Q4 2013: 1.25 Q4 2014: 1.23 EUR POISED TO TREND LOWER Relative central bank policy: favours EUR in near term; but weighs on it in long term Growth outlook is negative for EUR Political back drop and lack is negative for EUR Trend is EUR negative Sentiment is bearish EUR EUR 14 YEAR AVERAGE IS:

40 APPENDIX JPY: BEARISH USDJPY FORECAST Q4 2013: 95 Q4 2014: 98 JPY POISED WEAKNESS BUT THERE ARE LIMITS Relative central bank policy: favours USD Growth outlook neutral: US outperforms, but Japanese outlook improving Political backdrop favours JPY Trend and sentiment favour USD Regardless of success or failure of BoJ; outlook for JPY is to trend lower USDJPY 39

41 APPENDIX GBP: BEARISH GBPUSD FORECAST Q4 2013: 1.45 Q4 2014: 1.44 GBP POISED TO TREND LOWER Relative central bank policy: favours USD Growth outlook favours USD Political backdrop neutral Trend and sentiment favour USD Low growth, elevated inflation, central bank change & negative sentiment are GBP negative GBPUSD Source: Bloomberg 40

USDCAD OUTLOOK CAMILLA SUTTON l CHIEF FX STRATEGIST l l June 2013

USDCAD OUTLOOK CAMILLA SUTTON l CHIEF FX STRATEGIST l416-866-5470 l CAMILLA.SUTTON@SCOTIABANK.COM June 2013 DIAL IN: 905-694-9451 (local to Toronto) PASSCODE: 6045472# CONFERENCE CALL COMMANDS Press 1