Foreign Exchange Commentary

Summary

• Canadian dollar firms as risk tone improves, metals rise.
• Euro currency breaks out of YTD range on downside after strong inflation reports in the U.S. push up yields significantly.
• U.S. 10-year yield declines modestly Wednesday to 4.63% following the sharp recent gains after breach of 4.50%.
• U.K. pound sterling rises, gilts lag after CPI beats expectations (eases less than expected).
• Japanese yen edges higher following jawboning, JGBs drop; trade balance beats.
• UBS downgrades forecasts for euro, yen given U.S. dollar strength.
• Euro volatility curve inversion fades away as traders seek haven.
• Mexico peso rises with peers as risk assets rebound.
• Kiwi dollar, yields rise after inflation data; RNBZ core inflation index fell to two-year low in first quarter.
• New Zealand yields seen capped as RNBZ pivots later in 2024.
• EIA: Crude +2,735 Bbl, median estimate +1,650 Bbl.
• Offshore yuan gains as funding costs climb.

Noteworthy

• Dollar Retreats After 5-Day Rally as U.S. Yields Drop, Yen Gains

• Canada Lifts Capital Gains Tax to Finance New Housing Measures

Canada on Tuesday said it would raise capital gains taxes on corporations and wealthy individuals to finance multi-billion dollar spending measures aimed at addressing rising disillusionment among younger Canadians about their financial prospects.

The capital gains measure, unveiled in the country’s annual budget plan on Tuesday, represents one of the biggest tax increases in recent Canadian policymaking. The additional revenue helps the Liberal government meet their promise to limit the size of the annual deficit and gives it more money for initiatives as Prime Minister Justin Trudeau aims to turnaround his government’s poor performance in public opinion polls with an election over a year away.

The fiscal policy plan triggered warnings from business groups that this would thwart efforts to encourage more business investment in the country, something Bank of Canada officials say is urgently needed to end an extended malaise in productivity. Economists say the hefty spending increases in Canada'a budget plan, coupled with expenditure increases released last month by provincial governments, could pose a headwind to efforts to slow inflation.

Canadian Finance Minister Chrystia Freeland said spending on programs and administration in the current fiscal year, ending March 31, 2025, would rise 6.7% to 480.5 billion Canadian dollars, or the equivalent of about $349 billion. The level of federal spending is over 40% higher than pre-pandemic levels, even after the removal of pandemic-fueled stimulus. The budget plan envisages budget deficits of about C$40 billion this year and next, fulfilling a promise Freeland made last fall.

To help finance spending on measures intended to increase housing supply, improve access to healthcare and feed school children – Freeland is increasing the rate on annual capital gains realized above C$250,000 from 50% to 66.6%. The higher rate applies to both corporations and wealthy individuals and is scheduled to take effect June 25.

The higher inclusion rate the first change in the capital gains levy in over two decades – is expected to raise C$6.9 billion this fiscal year, with corporations accounting for over two-thirds of that amount, and C$19.36 billion over five years. The budget plan contemplates about C$36 billion in net new spending over the next half decade.

In budget plan documents, Freeland said for younger Canadians, the promise of a prosperous, middle class life is at risk. “Those at the top have been getting richer while younger generations struggle to buy a first home and afford to start a family,” she said. “Canada’s potential must be leveraged to fix this.”

Canada is maintaining the capital gains exemption from the sale of a principal residence, but the higher inclusion rate applies to transactions involving investment and vacation properties.

Officials estimate that the higher capital gains inclusion rate would affect only a small fraction of the population, or 0.13%, with average income of C$1.4 million or higher.

Freeland said the change in capital gains taxes is not expected to hurt Canada’s business competitiveness. But at least one business group disagreed.

“It is a desperate measure that will increase uncertainty in an economy that needs more investment,” said Robert Asselin, Vice President of Policy at the Business Council of Canada. “We’re making capital more expensive in our economy.”

The Liberal government is trailing its traditional rival, the Conservatives, by a wide margin in nearly all public opinion surveys, stemming in part from the rapid climb in inflation and the subsequent squeeze on housing affordability. Authorities estimate that, based on recent immigration-fueled population growth, Canada faces a housing shortage of up to four million units, and the vacancy rate hit a record low of 1.5% last year.

The budget plan incorporates previously announced measures, totaling C$8.52 billion over five years, aimed at narrowing the housing-supply gap by 2031 and providing support to renters.

“This is the most critical budget from a political point of view the Trudeau Liberals have put out,” said Darrell Bricker, Chief Executive of Ipsos, a Canada-based polling firm. “They are running out of chances and time to turn voter opinion around” before the election in the fall of next year.