Economists at TD Bank are calling for more aggressive rate tightening than the market currently expects in Canada, and a stronger loonie as a result.

The big news for the market in the past weeks, TD says, was the release of minutes by the US federal reserve Board that the market read as dovish.

“Although the Fed is clearly rounding the final base in its tightening campaign, there is less agreement on how long it will remain on the sidelines,” it says. “In our view, prospects for a weakening in both housing and consumer activity this year will result in a downshift in U.S. growth to below trend in the second half.”

“This softer outcome would be consistent with the term structure of interest rates, where higher short-term rates in the near term should lead to a mild inversion of the U.S. yield curve. After signs of a slowdown emerge after mid-year, look for the dawning of a down-cycle in short-term interest rates to take shape, and an upward sloping yield curve to return,” TD predicts.

TD says that the Canadian bond market took its direction from the U.S. market, although, “the rally on this side of the border was considerably more pronounced. Notably, 1- and 2-year yields declined by more than 15 basis points in Canada, about twice the drop that was registered in comparable U.S. yields, while 10-year yields in both countries remained anchored.”

“In our view, this significant steepening action in Canada relative to the U.S. was probably overdone, since this week’s economic and currency-market developments did not alter the underlying picture. As such, we continue to stick to our belief that the Canadian central bank will raise rates by an additional 0.75 percentage points in the coming months,” it forecasts. “This action is somewhat more aggressive than what’s currently built into markets following this week’s rally, and hence should provide support to the loonie, which we expect to touch a new 14-year high of US88¢ by the end of the first quarter.”