Expected USD/CAD Range: 1.065 – 1.070 Update: With the nearly year-long taper debate behind us and with little economic data to go, this morning’s prints seemed to confirm the two obvious themes in the market. The US economy is humming (GDP above consensus) and the Canadian economy is operating at lower than optimal inflation rates. The Canadian Dollar reacted somewhat violently to the news and gave up half a penny. The impact seemed to be temporary though and we are now back at yesterday’s closing levels of 1.068. The loonie seems to be holding on to the 1.07 level with some surprising tenacity despite the negative data. The Big Picture: The Bank of Canada remains cautiously optimistic on the Canadian economy but has dropped its tightening bias since October. Indeed, at the moment, the primary concern of Governor Poloz seems to be inflation rates that are well below the Bank’s 2% target and the consequent possibility of disinflation (declining inflation rates as opposed to the scarier prospect of deflation). With concerns about elevated household debt levels and an overheated housing market still lurking in the background, the Central Bank faces an interesting challenge in balancing the need for economic growth against further increases in household debt or frothy activity in the residential real estate market. All of which brings us to the Canadian Dollar which has never been explicitly a focus of our Central Bank whose mandate is inflation targeting but which is now implicitly in the crosshairs of Governor Poloz as a tool for stimulating economic activity without further burdening the household sector. Interestingly, the Governor has recently commented that the link between a stronger US economy and greater exports is not as strong as he would prefer, arguably further fueling the view that a lower Canadian Dollar is what he would prefer. In the United States, the ongoing (somewhat halting) recovery has led the Federal Reserve to begin the process of cutting back (“tapering”) its two remaining extraordinary monetary stimulus programs. Globally, the commodity boom has ended (or is at least sputtering). Relatedly, Chinese and other emerging market economies have slowed notably and while some of the data from China is encouraging, it is becoming clear that sub 8% growth in China is here to stay. As a result of all of this and not surprisingly, the CAD has declined over 7% in 2013 and we expect it to continue an orderly and gradual decline in 2014.
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