2025 Outlook – Balance Sheet Management

Roman Dubczak: Hello, everyone. I’m Roman Dubczak, Deputy Chair at CIBC Capital Markets. 2025 appears to be an eventful year. I’m not going on a limb with that prediction, and it certainly seems as though the first week or so, which is where we are right now, appears to be shaping up with a lot of news for the markets to digest. At CIBC, we’re here to provide you with differentiated insights to help you navigate all of these financial markets and what’s going on. And I’m pleased to lead today’s discussion on balance sheet management with our experts at CIBC Ian Pollick, Global Head of Fixed Income, Currencies and Commodity Strategy, Sarah Ying, Head of Foreign Exchange Strategy, and Jeff Gabriel, Head of Corporate Solutions. Each of our experts will recap the events of the last financial year, Each of our experts will recap the events of the last financial year, looking at financial and currency markets, and also provide some insights on what they see for 2025 and perhaps beyond. At the start of 2025, we face several trends that our clients have a keen eye on, namely political change, both national and global, shifts in yield curves, and the resultant volatility in financial markets. A full agenda of concern, so to speak. So, Ian, why don’t you start us off with your perspective on the past year and what might be the key themes in 2025?

Ian Pollick: Absolutely. So, 2024 was supposed to be ‘the year of the bond’. The bond market is going to come back, very high total returns. That’s not really what happened. You know, depending on where you live on the yield curve, two-year yields, five-year yields, which are really dominated by monetary policy, they fell. And they fell pretty aggressively in markets like Canada and in Europe. But the long end of the yield curve didn’t. And this is a theme we think we talked about almost a year ago today. Supply growth, concerns about a slowing disinflationary progress, all really led to the back end of the curve not really responding all that much. 30-year yields are higher over the year. Ten-year yields are effectively unchanged. And so, you take a step back and say what does that mean for 2025. Well, there’s really two big themes. Number one is, uncertainty. You know, we do not know what tariffs are going to look like coming out of the US administration. And therefore, when we’re thinking about inflation, when we’re thinking about supply, we’re thinking about the external backdrop. Our base case is that you get relatively weak global growth. But inflation that actually may not fall as fast as people want. And so, it engenders, two things – a slower policy path in some of the bigger economies like the US, a potentially more aggressive path in smaller economies like Canada and Europe. But the long end of the yield curve is still going to exhibit very, very similar traits as 2024, particularly in a world where we do get, for example, larger than expected tariffs. That reflation trade is, I think, the most important thing that we should be talking about. And it’s very early on in the year. So, we don’t know what that trajectory looks like just yet. On top of that, I would say that when you look at the growth in supply in a market like Canada, who bought the supply, who’s buying bonds? I mean, this is obviously the most important question. And it’s non-resident investors. And so, international investors have come into our market, which made a ton of sense in 2024. Canada, started to diverge from the US, The Bank of Canada cut interest rates first. That may not be the story this year. And so, in a world where supply is growing, one of the attendant question is, “Well, who’s going to buy it?” If it’s not the traditional players, then we should expect an even larger back up in yields.

Roman Dubczak: Okay, well certainly interesting perspective. And you did mention a year ago we had this conversation, all of us for that matter. And so, Sarah, a year ago we were talking about the Canadian dollar, and probably worthwhile raising given what Ian just said, what the biggest surprise was in 2024…

Sarah Ying: Yeah.

Roman Dubczak: Certainly things did change. And what you think those surprises may be for 2025.

Sarah Ying: Yeah, so 2024 was really the year of dollar dominance, which was very surprising. The US data is exceptionally strong. That has really caused the fed to take a much slower approach to normalizing interest rates. And you have this big dichotomy with the US and the rest of the world, where other central banks have taken a quicker pace of normalization. And that divergence really is the cause of dollar strength. If you combine the interest rate story with the US elections and the Trump trade, that’s really why we’ve seen the dollar outperforming some of its peers. Now, if you look at dollar CAD, we’ve seen a little bit of a milestone as well. Over the past ten years or so, dollar CAD has been a very rangebound currency, call it between 1.20 and 1.40. After the US elections, we really started to see the market testing that 1.40 mark. And as we move into 2025, one of our biggest thesis is that the dollar can’t stay up there. So, we’re looking for a dollar CAD to move up to 1.46 by mid-year. That’s mostly driven by The Fed moving at a slower pace in the bank, but also driven by US election uncertainty. In the latter half of the year, the market’s probably going to care a little bit more on execution on some of these Trump announcements. That’s going to cause the Trump trade to wane a little bit. And if you do believe that The Fed can move a little bit faster than what the market is pricing in now, that should also cause the dollar to weaken a little bit in the latter half of the year. But overall, if we’re staying above the 1.40 mark, it’s a little bit of a structural shift for the Canadian dollar as well.

Roman Dubczak: It sure is. Thanks, Sarah. Thanks for that. So, Jeff, who got..? Let’s maybe look at 2024 a bit because your desk helps clients position for the risks. You know, we saw a diverging yield curves. We saw lots of volatility in FX. What played out last year for our clients? And then we can get into what you think you’re doing. And what you think we’ll be doing?

Jeff Gabriel: Certainly. 2024 really was a tale of two halves. From the first part of the year, we had a somewhat anticipated market environment where we had declining interest rates with central bank cutting. You know, there’s variation in the market in terms of directionality of the dollar. But for the most part, people were pretty pragmatic and programmatic when it came to their hedging solutions and how they wanted to manage their business. Of course, then we get into the back half of 2024. We became more headline and event driven in terms of, you know, the market volatility that ensued after, Donald Trump, you know, was evidently going to become president. And we really did see a shift in client activity. People that were managing the currency risk kind of, took a step back, particularly in Canada, just because we had such a variation on the currency from the 1.34s up to the 1.43s, but where we saw an uptick in hedging, were clients that were trying to get project finance and infrastructure deals across the line. And although the prevailing path of rates was declining, people wanted to get their projects grandfathered, especially in the US, if we had some customers that were concerned with the IRA or whatever surgery that would happen there. You know, it wasn’t about, “What’s the potential path for cost savings down the road?” It’s ensuring my project is good to go now so that I can get it on the books and get it done and avoid any adjustments that could come about from a change in federal policy, be it either now in Canada, or the US. And I think in 2025, hedging activity is going to look a lot like the back end of 2024. And what I think our clients are going to ask from us, quite frankly, is going to be some form of product evolution. Products that will satisfy the need to hedge but also provide financing activities for them. So, kind of, a 2-in-1 package because you’re now managing the various legal risks, political risks when you’re affecting business across the border. And we just don’t really know what it’s going to look like. We’ve see all spectrums. So, that’s what I think the, you know, the future holds for 2025 for our customer base.

Roman Dubczak: Yeah… We don’t know what it’s going to look like, but we think we know what it’s going to look like.

Jeff Gabriel: That’s absolutely it.

Roman Dubczak: That’s the best we can do.

Jeff Gabriel: And there’s plenty of opinions, so, you know, manage accordingly. And our customers seem to be, you know, following that pace.

Roman Dubczak: Okay, thanks. Thanks, Jeff. Very good. So Ian, with that in mind, what could possibly be the case of, “what we didn’t know that was going to happen in 2025”, or, “We didn’t think that was going to happen”, i.e. risks to what we were just talking about, in terms of scenarios.

Ian Pollick: I think we should start off with the bond markets forecast, right? Let’s take it from there. So, what’s the bond market telling us right now? That the US economy is going to slow down in terms of its growth output and inflation will stay relatively high. In turn, The Fed only cuts twice. In Canada. the bond market says, “Well, the Bank of Canada is going to keep cutting rates, but at a very slow pace.” And they’re going to keep cutting rates until 2026. And so, when you take a step back and say, “Well, what’s the most obvious risk to that forecast?” It’s use economy that decelerates much faster than it’s expected it. And to Sarah’s point, maybe one that sees more interest rate cuts delivered. And in Canada, the risk is that you see green shoots in the second half of 2025, just based on all the interest rate cuts that were delivered and potentially some less, punitive tariffs.

Roman Dubczak: Right. Really interesting points. How about the political aspect of it? So, you’ve got early days of 2025, talk of the new administration working with the new Congress to make some significant changes. Is there reason to be concerned that, that works out well, or doesn’t work out well with incumbent pressure on the US bond market as a result? I do think there’s a little bit less, synthesis in the US administration than people give it credit for.

Ian Pollick: Okay. And I do think that the, focal point of the first few things that they’re going to do is largely aimed at immigration, not necessarily on the fiscal side. And so, I think a lot of the concerns the bond market has may actually be obviated very early on into the presidency. And what that means is that, you may have this lower interest rate environment for a very, very brief time this year. And, so when we think about hedging opportunities, when you think about issuance opportunities, a. you have to be very quick, and b. I think this window is going to be open, but it’s going to be open for a very short period of time. So, let’s call that the first quarter of this year.

Roman Dubczak: Okay. Good. And Sarah, what do you think some of the risks are in the FX markets? Everyone’s got their eye on US-CAD. That’s probably where you know, most of the interest lies with their clients. How much of a variation do you think they need to factor in here in terms of the coming year at least?

Sarah Ying: So, tariff risk is something that the FX market is extremely sensitive to. So, over the past, call it, month or so, we do think that there’s been a significant pricing in of Trump’s tariff verses $2 CAD, probably around 3 cents, or so. So, if it wasn’t Trump or if there was no tariff for us, we probably see dollar CAD closer to 1.40 or 1.41 as opposed to 1.43, 1.44 today. Okay. In terms of moving forward, obviously it would depend on the outlook of what gets implemented and how. Our base case scenario is that the 25% tariff that was announced in late November wouldn’t be implemented, or if it was implemented, it wouldn’t be permanent. The market kind of agrees because you can see that the tariff premium is not that big. Usually most of these tariffs are felt through to the currency in call it 80 to 90% capacity. So, let’s say a 25% tariff. That should lead to a 25% depreciation at CAD. We’ve only seen 2 to 3%. So, in terms of how that could evolve moving forward, if let’s see the talks get more constructive, we probably get a penny or two discount off the dollar. If they get worse, we do think that dollar CAD can move materially higher In terms of, “how high?” Maybe 1.50 looks like a reasonable cap. And the reason why is, if, let’s say Trump says something about these 25% tariffs, that’s a huge number. But whether or not that would continuously and fully pass on to the currency, probably you don’t see that full impact. And the reason why is because we do think that there’s going to be ongoing negotiations between the US and Canada on how to resolve or ameliorate these tariffs. If you see a full impact, that’s more of a longer-term outcome that we don’t think is going to be priced.

Roman Dubczak: Now, I did say the US-CAD was the focal point, but how about other currencies? And just like in real brief summary, other currencies that may be at risk in the coming year.

Sarah Ying: Yeah, absolutely. So, over the past month or so you’ve seen the commodity currency get hit the most. So, Australia, Canada, New Zealand, most of that was driven by the global growth story, growth slowing down on these potential tariffs, on these tariffs and their impact to China. Moving forward in terms of some of the things to watch is what happens in Europe if, let’s say, Trump does start to focus on these critical imports. For example, most of the aluminum, steel tariffs that’s mostly a European story, a German story. South Korea and Japan is also somewhere to watch for, especially for these critical imports to the US. So, those are kind of the regions to look and be aware of.

Roman Dubczak: Great. Thanks, Sarah. Okay, Jeff, just to help us wrap up here, what are some of the things that the desk at CIBC is working on to help our clients navigate what seems to be what will be an exciting 2025, to say the least. Certainly, our advisory services are doing what we, you know, traditionally do and that’s follow our client needs.

Jeff Gabriel: Yeah. So, we’re spending more time than ever meeting with clients and discussing the pain points. And that helps drive the product innovation and evolution that we have on the desk. Thematically, I think in the coming year, net investment hedging, which hasn’t always been in vogue, may actually be back in vogue, just given the fact of the volatility from cross-border M&A, currency fluctuations that can really, have implications for the valuations that some of our friends and private capital are looking at and our friends in corporate banking. And then certainly, I expect us to continue with financing type transactions such as, ABS facilities, Asset Backed Facilities, as well as DCHs. Like, I really think that customers will be looking for liquidity and flexibility as they try and navigate some of the complexities that we haven’t seen in a while evolve in the marketplace.

Roman Dubczak: Sure. Thanks. Yeah. And look, I’ll tie back to a conversation on a previous webcast on M&A activity and that our team is suggesting is going to be a substantially busier year this year than last. And that makes perfect sense despite the volatility in the markets.

Jeff Gabriel: That’s right.

Roman Dubczak: And so Ian, Sarah, Jeff, thanks for a terrific conversation, as always. It bodes to be a very busy year ahead of us. And as I use the words “exciting”/”volatile”. Let’s see what how this pans out. But I appreciate your insights. Truly differentiated, I think, and want to thank our clients for joining us today. Hope you all have a very successful, prosperous and, happy 2025 and I look forward to speaking with you again soon. Thanks.