Canadians are going to the polls today in an election that was supposed to be a cakewalk for Justin Trudeau’s Liberals
In a surprise move on 15 August, Prime Minister Justin Trudeau called for a snap election to be held in less than six weeks. The campaign started off well with the Liberal Party doing better than expected but opposition parties have been eating away at this lead and it now appears that they could win enough votes force another minority government. A recent poll showed Liberal support going down from 50%+ to around 44%.
The Liberals currently hold 155 out of the 388 seats in the House of Commons. Opinion polls suggest that there are greater risks for them losing a few specific ridings, rather than being able to add electors - they need 15 more wins to form a majority government which most analysts now view as being unlikely.
The Canadian political debate has been full of social and economics topics, but we think there are two topics that will matter for markets and the Canadian dollar - fiscal stimulus plans and energy/pipeline policy.
A continuation of Trudeau's massive fiscal support program should be welcomed by the markets
Canada's pandemic-response strategy was dominated by a massive fiscal support program led by Prime Minister Trudeau. The program reached 20% of GDP and is being unwound gradually.
Policymakers on both sides are scaling back stimulus quickly with election promises about how they'll spend more time balancing budgets over the long term. There is an expectation that a Conservative government will scale back stimulus quicker than Liberals which would likely see lower inflation. This could allow for a major Bank of Canada policy tightening outlook to occur with greater probability providing support for the loonie.
The outlook for Canada’s banking stocks has also been dimmed by Prime Minister Justin Trudeau's commitment to hike tax rates on all earnings over CA$ 1bn. That said, in the short term the prospect of an extended fiscal stimulus should be the primary driver in markets and could benefit the Canadian dollar through expectations of fiscal support.
Trudeau is pro-pipeline, but his potential coalition partners are not
The oil industry is a vital part of Canada's economy, and it has been experiencing some long-standing issues that could dent its ability to take advantage of higher oil prices.
With the recent cancellation of Keystone XL, Canada is now at a disadvantage when it comes to competing with resources from other countries. The lack of pipeline capacity remains a major issue with most producers relying heavily on rail systems rather than pipelines.
Despite the Liberals’ official stance for increasing pipeline capacity, left-wing parties like NDP are explicitly opposed to it. This means that Trudeau will have to rely on coalitions with these anti-pipeline politicians which will likely result in no resolution to the extension of the Keystone XL pipeline.
Conversely, the Conservatives are not only in favour of new pipeline projects, but also retain the friendliest stance among all parties towards Canada's traditional oil-and gas industry. Their plans for a transition away from carbon fossil fuels look likely to be more gradual than that proposed by other political parties. A Conservative win may favor a stronger Canadian dollar in the medium term.
Bottom line for the loonie
The Canadian dollar has likely discounted some degree of political uncertainty as polls showed the Liberal party's hopes for an outright majority are becoming more and more distant. There is evidence that this is the risk premium has already been embedded into USD/CAD according short-term fair value models that suggest that the USD/CAD is currently 2% overvalued.
When discussing the two main policy themes that we think markets are mostly keeping an eye on in this Canadian election campaign, we suggest that a minority win by the Liberals could see CAD benefit from better fiscal stimulus prospects, and a minority win by the Conservatives may mean CAD being supported through a better outlook for the oil and gas industry in Canada.
Ultimately, however, the market reaction will depend much more on whether the vote will allow room for a workable majority to emerge and guarantee political stability in the coming years, rather than which party will come up as the winner.
The best-case scenario for CAD is undoubtedly a majority win by either one of the two parties, but that seems to be a low-probability outcome given the current polls. The most likely scenario of either the Liberals or the Conservatives winning most seats but having to rely on other parties to govern may ultimately have a contained impact on CAD.
A minority win would pave the way for a potential hung parliament. We should know more on Tuesday, as post-election comments start to outline the different possible political scenarios, but from an FX point of view, any political-noise risk premium embedded in CAD may remain in place until a clear working majority materializes.
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