Quick Hit International securities transactions: A currency story

Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 May-18 Jul-18 Sep-18 Nov-18 22 23 24 25 26 27 28 29 21 211 212 213 214 215 216 217 218 FICC Strategy January 18, 219 - (Vol. III, No. 9) Quick Hit International securities transactions: A currency story Usually when we think of the relationship between the loonie and the greenback, interest rate differentials and commodity prices tend to be the focal points. Our own modeling relies heavily on these variables. But don t underestimate the importance of capital flows when it comes to influencing the currency story. So while it stood in the shadows of today s CPI data release, we d draw attention to another StatCan release: Canada s international transactions in securities a rich data set, for the reference month of November, that give us a gauge of foreign demand for Canadian financial assets and the Canadian dollar. Foreign investment in Canadian securities rebounded nicely to $9.5 billion, up from $4. billion in October. At the same time, Canadian investors sold $4.1 billion of foreign securities, driven primarily by a divestment in equity and investment fund shares. The combined impact (i.e., foreign buying of Canadian assets plus repatriation by Canadian investors) propelled net capital inflows to a hefty $13.5 billion, a decisive swing from what had been an $11. billion net capital outflow in the prior month (Chart 1). Despite November s big-time net capital inflow, year-to-date figures remain uninspiring. During the first eleven months of 218, net portfolio inflows amounted to just $18.4 billion, the weakest tally in over a decade and off a startling $17 billion compared to the prior yearto-date (Chart 2). From a fixed income lens, international investors bought $7.8 billion of Canadian bonds, up from $4.4 billion in October. Net foreign flows in GoC, provi and corporate bonds were positive, while non-residents divested out of Canadian money market paper and muni bonds. Speaking of the loonie, foreign investors increased their holdings of C$-denominated bonds by roughly $2 billion from October. Once again, however, the 218:YTD tally tells another story, having decreased sharply (i.e., net selling of C$-denominated bonds) compared to significant net buying in 217:YTD (Chart 3). Indeed, so far in 218 we have attracted a lot less foreign buying of our securities, in stark contrast to the hefty inflows in recent years ($188.5 billion 217:YTD, and $159.1 in 216:YTD). This deterioration in one part of our balance of payments might help explain the downward pressure on the loonie in 218, causing it to trade cheap, relative to many fair value currency models (including one run by our very own colleagues in Economics). To be fair, there are other reasons for a softer loonie, among them a more dovish BoC. Markets aren t even discounting a single hike this year, although Canadian economists still see a patient BoC tapping the brakes once or twice later this year maintaining Canada s negative interest rate spreads vs the U.S. Still-elevated geopolitical uncertainty (e.g., NAFTA/USMCA ratification worries) is another reason for a weaker Canadian dollar. As evidenced by the partial shutdown of the U.S. federal government, the governing relationship between the Democrats (who now hold the majority within the House of Representatives) and the Republicans is off to a rocky start, to put it mildly. Although the new trade deal is expected to pass this year, the ratification process may not be as smooth sailing as the market anticipates, creating a level of uncertainty that poses significant risks for exposed assets and markets like the USD/CAD. With that said, the loonie should receive some support from bolstered crude oil prices. WTI crude oil has risen ~1.1% to US$52.66 per barrel, at the time of writing, and is up ~15% so far this year. And given OPEC s production cuts and expectations of resilient demand, the loonie may be set for further uptrend this year (already up ~3% against the greenback year-to-date). But unless/until foreign portfolio net inflows recover from the year-to-date trend, C$ might continue to trade cheap to fair value models. Chart 1: Net capital flows rebound in November Net flow on portfolio investment Chart 2: Slowdown in YTD net capital flows Net flow on portfolio investment: 11-month rolling sum 4 2 3 15 2 1 14 1 5 18-1 -2-5 -3-1 PLEASE SEE END OF DOCUMENT FOR IMPORTANT DISCLOSURES Sandra Kagango FICC Strategy 1

Chart 3: A closer look at non-resident portfolio investment/(divestment) in Canada Net foreign investment in Canadian portfolio securities: 218YTD vs 217YTD 16 14 12 1 8 6 4 2-2 -4 19 Money market 49 2 Bonds Equities -31 GoC Fed'l crowns 4 9 Note: Year-to-date based on January to November data 67-16 13 52 Public Sector Strategy January 18, 219 Net buying/(selling) of Canadian bonds: By sector, currency of issue, geographic region Provi/ muni 19 217:YTD Corp C$ US$ Other US UK Other Europe 26 6-2 218:YTD Japan Other Sandra Kagango FICC Strategy 2

January 18, 219 Table: Canada s international transactions in securities, November 218 International transactions in securities, portfolio transactions in Canada and foreign securities, by sector, currency of issue, and geography Current Previous 2 Months Ago Month Month Nov-18 Oct-18 Sep-18 3 Month Sum 6 Month Sum 12 Month Sum 218 YTD 217 YTD Total 217 Total 216 (A) Foreign inv. In Canadian securities 9,454 3,969 7,789 21,212 52,56 88,465 87,87 188,58 189,166 17,93 Canadian money market instruments(i) -49-2,163 6,849 4,277 7,425 19,96 18,582-13,473-12,95 4,178 Federal government 1,69 1,439 2,956 6,85 5,584 2,667 3,934-6,45-7,312-3,198 Federal government enterprises -1,522-886 752-1,656-1,584 3,469 3,53-2,527-2,111-352 Provincial governments 162 779 2,364 3,35 4,193 8,224 5,122-6,586-3,484-885 Provincial government enterprises -58-855 -341-1,254-1,551-389 67 474 18 9 Private corporations -681-2,64 1,118-2,23 783 5,989 6,46 1,29 792 8,68 Canadian bonds(ii) 7,782 4,352-317 11,817 29,87 46,55 49,28 147,939 144,714 112,7 Bonds: Net sector by flow Federal government 3,6 1,147-3,613 54 1,95-31,581-3,93 29,824 29,173 25,26 Federal government enterprises -338-1,213 2,583 1,32-5,837-1,217 4,494 17,54 11,829 9,216 Provincial governments 2,253 1,565-3,87-52 85 3,54 7,36 27,812 24,46 6,643 Provincial government enterprises -83-27 -11-463 1,928 1,496 1,468-59 -562-1,519 Municipal governments -26 54 18 136 19-562 -133 88 451 132 Private corporations 2,97 3,69 4,586 1,625 3,915 74,378 67,73 72,473 79,778 72,972 Bonds: Net Flows by Currency of Issue Canadian bonds, issued in CAD 2,414 355-164 2,65 2,795-25,917-16,289 59,168 49,54 29,158 Canadian bonds, issued in USD 1,93 3,39-7,41-2,639-5,74 17,118 13,496 61,224 64,846 54,237 Canadian bonds, issued in other forex 4,275 688 6,888 11,851 32,15 54,855 52,74 27,546 3,327 29,37 Bonds: Net Flows by Geographic Area USA 2,45 87-1,356 776 3,62-6,686-275 74,444 68,33 59,397 UK -2,771 2,285 1,715 1,229 3,127 23,355 18,719 36,415 41,51 28,521 Other Euro 3,379 3,623 378 7,38 14,573 25,774 25,964 17,22 17,12 26,498 Japan -122 956-1,18-184 1,692-3,3-1,584-2,653-4,369-5,715 Other OECD 974 1,14 2,851 4,839 6,341 1,853 1,472 3,426 3,87-2,6 All other countries 4,277-3,615-2,886-2,224 1,73-3,945-4,19 19,11 19,175 6,599 Subtotal: Debt Securities (i+ii) 7,374 2,189 6,533 16,96 37,297 66,16 67,864 134,465 132,617 116,88 Canadian equity and investment fund shares 2,81 1,78 1,256 5,117 14,761 22,45 19,945 54,43 56,548 53,215 Outstanding Issues 3,637 3,135 1,239 8,11 15,754 27,95 24,954 13,544 16,495 36,224 New issues, retirements or FDI -1,556-1,355 17-2,894-993 -5,453-5,7 4,498 4,52 16,985 (B)Canadian investment foreign securities -4,91 14,921 1,562 21,392 45,289 91,43 69,413 62,666 84,656 12,883 Foreign money market instruments 679 977 122 1,778 2,242 3,21 3,62 3,618 3,766-1,593 Foreign bonds 652 5,22 5,267 1,941 35,152 61,484 59,46 1,238 12,262-5,529 Foreign equity and investment fund shares -5,422 8,922 5,173 8,673 7,895 26,79 6,891 48,81 68,628 2,5 (A-B) Net Flow on Portfolio Investment 13,545-1,952-2,773-18 6,767-2,938 18,394 125,842 14,51 157,21 Sandra Kagango FICC Strategy 3

FICC Strategy January 18, 219 Corporate Credit Warren Lovely Connor Sedgewick, CFA +1 416-869-8598 Warren.Lovely@nbc.ca +1 514-879-3182 Connor.Sedgewick@nbc.ca Catherine Maltais Pete Metzger, CFA +1 514-879-227 Catherine.Maltais@nbc.ca +1 416-869-867 Pete.Metzger@nbc.ca Taylor Schleich Relative Value Models +1 416-869-648 Taylor.Schleich@nbc.ca Drew Lloyd +44 ()2-7488-9379 Drew.Lloyd@nbc.ca Important Disclosures General This Report was prepared by National Bank Financial, Inc. (NBF), (a Canadian investment dealer, member of IIROC), an indirect wholly owned subsidiary of National Bank of Canada. National Bank of Canada is a public company listed on the Toronto Stock Exchange. The particulars contained herein were obtained from sources which we believe to be reliable but are not guaranteed by us and may be incomplete and may be subject to change without notice. The information is current as of the date of this document. Neither the author nor NBF assumes any obligation to update the information or advise on further developments relating to the topics or securities discussed. The opinions expressed are based upon the author(s) analysis and interpretation of these particulars and are not to be construed as a solicitation or offer to buy or sell the securities mentioned herein, and nothing in this Report constitutes a representation that any investment strategy or recommendation contained herein is suitable or appropriate to a recipient s individual circumstances. In all cases, investors should conduct their own investigation and analysis of such information before taking or omitting to take any action in relation to securities or markets that are analyzed in this Report. The Report alone is not intended to form the basis for an investment decision, or to replace any due diligence or analytical work required by you in making an investment decision. Any opinions expressed herein reflect a trading perspective. NBF, or its affiliates may publish fundamental research on the subject issuer(s), which may reflect a different opinion. This Report is not produced by the NBF Research Department and has not been reviewed by the NBF Research Department. This Report is for distribution only under such circumstances as may be permitted by applicable law. This Report is not directed at you if NBF or any affiliate distributing this Report is prohibited or restricted by any legislation or regulation in any jurisdiction from making it available to you. You should satisfy yourself before reading it that NBF is permitted to provide this Report to you under relevant legislation and regulations. National Bank of Canada Financial Markets is a trade name used by National Bank Financial and National Bank of Canada Financial Inc. National Bank Financial Inc. or an affiliate thereof, owns or controls an equity interest in TMX Group Limited ( TMX Group ) and has a nominee director serving on the TMX Group s board of directors. As such, each such investment dealer may be considered to have an economic interest in the listing of securities on any exchange owned or operated by TMX Group, including the Toronto Stock Exchange, the TSX Venture Exchange and the Alpha Exchange. No person or company is required to obtain products or services from TMX Group or its affiliates as a condition of any such dealer supplying or continuing to supply a product or service. Canadian Residents NBF or its affiliates may engage in any trading strategies described herein for their own account or on a discretionary basis on behalf of certain clients and as market conditions change, may amend or change investment strategy including full and complete divestment. The trading interests of NBF and its affiliates may also be contrary to any opinions expressed in this Report. NBF or its affiliates often act as financial advisor, agent or underwriter for certain issuers mentioned herein and may receive remuneration for its services. As well NBF and its affiliates and/or their officers, directors, representatives, associates, may have a position in the securities mentioned herein and may make purchases and/or sales of these securities from time to time in the open market or otherwise. NBF and its affiliates may make a market in securities mentioned in this Report. This Report may not be independent of the proprietary interests of NBF and its affiliates. This Report is not considered a research product under Canadian law and regulation, and consequently is not governed by Canadian rules applicable to the publication and distribution of research Reports, including relevant restrictions or disclosures required to be included in research Reports. UK Residents This Report is a marketing document. This Report has not been prepared in accordance with EU legal requirements designed to promote the independence of investment research and it is not subject to any prohibition on dealing ahead of the dissemination of investment research. In respect of the distribution of th is Report to UK residents, NBF has approved the contents (including, where necessary, for the purposes of Section 21(1) of the Financial Services and Markets Act 2). This Report is for information purposes only and does not constitute a personal recommendation, or investment, legal or tax advice. NBF and/or its parent and/or any companies within or affiliates of the National Bank of Canada group and/or any o f their directors, officers and employees may have or may have had interests or long or short positions in, and may at any time make purchases and/or sales as principal or agent, or may act or may have acted as market maker in the relevant investments or related investments discussed in this Report, or may act or have acted as investment and/or commercial banker with respect hereto. The value of investments, and the income derived from them, can go down as well as up and you may not get back the amount invested. Past performance is not a guide to future performance. If an investment is denominated in a foreign currency, rates of exchange may have an adverse effect on the value of the investment. Investments which are illiquid may be difficult to sell or realise; it may also be difficult to obtain reliable information about their value or the extent of the risks to which they are exposed. Certain transactions, including those involving futures, swaps, and other derivatives, give rise to substantial risk and are not suitable for all investors. The investments contained in this Report are not available to retail customers and this Report is not for distribution to retail clients (within the meaning of the rules of the Financial Conduct Authority). Persons who are retail clients should not act or rely upon the information in this Report. This Report does not constitute or form part of any offer for sale or subscription of or solicitation of any offer to buy or subscribe for the securities described herein nor shall it or any part of it form the basis of or be relied on in connection with any contract or commitment whatsoever. This information is only for distribution to Eligible Counterparties and Professional Clients in the United Kingdom within the meaning of the rules of the Financial Conduct Authority. NBF is authorised and regulated by the Financial Conduct Authority and has its registered office at 71 Fenchurch Street, London, EC3M 4HD. NBF is not authorised by the Prudential Regulation Authority and the Financial Conduct Authority to accept deposits in the United Kingdom. U.S. Residents With respect to the distribution of this report in the United States of America, National Bank of Canada Financial Inc. ( NBCFI ) which is regulated by the Financial Industry Regulatory Authority (FINRA) and a member of the Securities Investor Protection Corporation (SIPC), an affiliate of NBF, accepts responsibility for its contents, subject to any terms set out above. To make further inquiry related to this report, or to effect any transaction, United States residents should contact their NBCFI registered representative. This report is not a research report and is intended for Major U.S. Institutional Investors only. This report is not subject to U.S. independence and disclosure standards applicable to research reports. Sandra Kagango FICC Strategy 4

January 18, 219 HK Residents With respect to the distribution of this report in Hong Kong by NBC Financial Markets Asia Limited ( NBCFMA ) which is licensed by the Securities and Futures Commission ( SFC ) to conduct Type 1 (dealing in securities) and Type 3 (leveraged foreign exchange trading) regulated activities, the contents of this report are solely for informational purposes. It has not been approved by, reviewed by, verified by or filed with any regulator in Hong Kong. Nothing herein is a recommendation, advice, offer or solicitation to buy or sell a product or service, nor an official confirmation of any transaction. None of the products issuers, NBCFMA or its affiliates or other persons or entities named herein are obliged to notify you of changes to any information and none of the foregoing assume any loss suffered by you in reliance of such information. The content of this report may contain information about investment products which are not authorized by SFC for offering to the public in Hong Kong and such information will only be available to, those persons who are Professional Investors (as defined in the Securities and Futures Ordinance of Hong Kong ( SFO )). If you are in any doubt as to your status you should consult a financial adviser or contact us. This material is not meant to be marketing materials and is not intended for public distribution. Please note that neither this material nor the product referred to is authorized for sale by SFC. Please refer to product prospectus for full details. There may be conflicts of interest relating to NBCFMA or its affiliates businesses. These activities and interests include potential multiple advisory, transactional and financial and other interests in securities and instruments that may be purchased or sold by NBCFMA or its affiliates, or in other investment vehicles which are managed by NBCFMA or its affiliates that may purchase or sell such securities and instruments. No other entity within the National Bank of Canada group, including National Bank of Canada and National Bank Financial Inc, is licensed or registered with the SFC. Accordingly, such entities and their employees are not permitted and do not intend to: (i) carry on a business in any regulated activity in Hong Kong; (ii) hold themselves out as carrying on a business in any regulated activity in Hong Kong; or (iii) actively market their services to the Hong Kong public. Copyright This Report may not be reproduced in whole or in part, or further distributed or published or referred to in any manner whatsoever, nor may the information, opinions or conclusions contained in it be referred to without in each case the prior express written consent of NBF. Sandra Kagango FICC Strategy 5