The Loonie’s Flight Is Probably Over

July 7, 2017

One of this summer’s oddities is the difference in official economic opinions between Ottawa and Washington. Where the US has experienced, if anything, a mild deterioration in momentum, the commentary suggests a roaring economy. Yet, here at home, officials have been downplaying Canada’s performance, even though the numbers show the country at the head of the G7 pack. The stronger Canadian dollar might explain the humbleness.

Since the early part of May, the Loonie has been on a tear. Climbing from lows near 72-1/2 US cents it has recently broke back above 77 cents for the first time since February. At the intraday high of 77.44 cents on Tuesday it had returned to levels not seen since last September. Some believe that this trend could easily send it through 80 cents.

 

 

Usually we would turn to the commodities market for an explanation of why the dollar is strengthening, or weakening.  That doesn’t apply in this case. For one, crude oil prices have been all over the map, rising from $44/barrel in the first week of May to $52 in late May, only to slump back to $42 later in June. In fact, crude is about a dollar weaker than it was on May 5th—the day the Loonie fell below 73 cents. Likewise, the price of gold is more or less right where it was on May 5th near $1220/oz.  The CRB commodity index is today about 5 points lower than on May 5th.  So, if it isn’t the commodity market propelling the Loonie, then what is?

Part of the answer is the continued weakening trend in the US dollar. Since May 5th the DXY dollar index has lost close to 3 points, breaking below 96 to reach its lowest levels since last autumn. Despite further tightening by the Fed and a solid equity market, confidence in the greenback has diminished, reflecting the moderation in growth.

If the Loonie was simply being dragged along for the ride and was underperforming its major peers, then our analysis would be done. Instead, we see that the gain of 5.2% since May 5th is second only to the New Zealand dollar, which is up 5.3%.

 

 

The Loonie’s ability to gain versus the majors as well as the US dollar stems from relative improvement in economic fundamentals, but it also reflects a sea change in market opinions regarding the Bank of Canada. Most economists have been conditioned into thinking Governor Poloz and crew (A) did not want to make any changes to interest rates  for a considerable time, and (B) wanted the Canadian dollar to remain at competitive (read ‘very low’) levels versus the Yankee buck. Even with the economy accelerating and the housing market on fire, the Bank resisted the urge to tighten policy and what cemented the expectation that this resistance would continue was how Mr. Poloz stayed the course after the Fed started to raise rates.  That has all changed now given that the Governor and others have started to hint at the need for higher rates in recent speeches.

The comments have been effective to the extent where the consensus is now calling a rate hike at next week’s Bank of Canada meeting. If Mr. Poloz delivers, this would be the first rate hike since September 2010 and would take the overnight rate to 0.75%. Note, this is still less than where the Bank got to in 2010.

 

 

Now that the Bank is joining the Fed, some may expect the Loonie to simply keep pushing higher, but there is an old saying of “buy the rumour and sell the fact” which applies here. If one or two rate hikes by the end of the year are already priced into the Canadian dollar, then the act of raising them will not be sufficient to move the needle further. Nor has the current Governor changed his spots. With the Loonie approaching 80 cents and the US economy not impressing, Mr. Poloz is not going to want to contribute to yet a less competitive dollar. I’m sure he is already a little uneasy about a 5% gain in just two months. And then there is the US dollar. While I don’t want to go out on a limb and call a bottom in the greenback, we are getting near to some key support levels. The Loonie might just return to its nest.

 

Upcoming events

Canada:  Housing starts, home prices, Bank of Canada meeting, new home prices,

US:  Consumer credit, wholesale inventories, Fed Beige Book, producer prices, CPI, retail sales, industrial production, Univ. of Michigan consumer sentiment

 

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