February 17, 2017 / 7:46 PM / 2 years ago

Canadian dollar investors nervously eye U.S. border tax threat

TORONTO (Reuters) - The recent strengthening of the Canadian dollar belies the threat of a proposed U.S. border adjustment tax that could slam the currency due to Canada’s heavy reliance on exports to its southern neighbor, forex strategists and fund mangers say.

A Canadian dollar coin, commonly known as the "Loonie", is pictured in this illustration picture taken in Toronto January 23, 2015. REUTERS/Mark Blinch

The loonie, as the Canadian currency is called, would be among the biggest losers if the Trump administration implements a border tax as part of its effort to crack down on what it sees as unfair competition from trading partners, analysts say.

They expect such a move would reduce the competitiveness of Canada’s exports as well as pressure the prices of its key commodities, such as oil, through a stronger U.S. dollar. Canada sends 75 percent of its exports to the United States.

The result could be a sharp drop in the Canadian currency, which is already down nearly 20 percent against the U.S. dollar since the summer of 2014, when oil prices peaked.

“The risk of that potential border tax adjustment I don’t think is fully priced in,” said Hosen Marjaee, senior managing director and portfolio manager at Manulife Asset Management.

The Canadian dollar has gained 1.5 percent against its U.S. counterpart since Donald Trump won the Nov. 8 presidential election, the best performance among the currencies of the G10 countries.

The Canadian dollar would need to fall 10 percent if the border tax is introduced to offset the negative impact on the competitiveness of Canadian exports, said Ian Gordon, FX strategist at Bank of America Merrill Lynch.

“Listening to the dialogue in Washington, the president and a lot of his advisers seem to be coming around more to the idea (of a border tax) than they were even a month ago,” Gordon said.

Trump, who has vowed to renegotiate the North American Free Trade Agreement with Canada and Mexico, told the Wall Street Journal last month that the border tax provision was “too complicated.”

The market has been “taking all the positives from the Trump election ... neglecting the negatives which have more to do with trade,” said Jimmy Jean, senior economist at Desjardins.

In a press conference alongside Canadian Prime Minister Justin Trudeau on Monday in Washington, Trump said he only wanted to tweak the trade deal with Canada, which boosted the Canadian dollar.

But the imposition of the border tax would “hit Canadian exports hard,” Canada’s C.D. Howe Institute said in a research report on Tuesday. It estimates Canada’s real gross domestic product would be reduced by almost 1 percent.

The border tax, which could leave U.S.-based companies unable to deduct import costs to reduce their tax burden, is among the sweeping changes proposed by the Republican-controlled House of Representatives. Corporate taxes also would be cut to 20 percent from 35 percent under the proposed changes.

“The border adjustment tax is what pays for the tax cuts and the Republicans won’t want to let the deficit explode,” Desjardins’ Jean said.

The measure still faces opposition from U.S. companies that rely on imports, and not all investors see the market mispricing the risk for the loonie.

“We’re not crazy big bears on the Canadian dollar,” said Ed Devlin, head of Canadian portfolio management at Pacific Investment Management Co. “If the border adjustment tax went through, we would be.”

Compounding the threat of the border tax to the Canadian dollar is the prospect that the U.S. Federal Reserve raises interest rates faster than the market expects, further inflating the value of the greenback. Fed policymakers currently project three rate hikes this year.

The Bank of Canada, conversely, is expected to hold rates steady as Canada’s economy gains momentum in the wake of the 2014-2016 oil price shock and may cut them if a border tax is implemented, analysts say.

Reporting by Fergal Smith; Editing by Denny Thomas and Paul Simao

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