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Updates (2013-2014)

Canadian Dollar Update

Expected USD/CAD Range: 1.102 – 1.110 Update: A variety of factors have converged in the last several days to drive the Canadian dollar lower. Yesterday morning we had lower than expected wholesale figures as well as technical supply of Canadian dollars having to do with an announced M&A transaction. Then later in the afternoon, the December Fed minutes were released indicating that hawkish members may begin arguing for interest rates hikes sooner than expected. This morning, we are seeing a general aversion to risk assets, including the commodity currencies, due to geopolitical risk, especially events in the Ukraine. All of that has caused a decline in the Canadian dollar of roughly 2% this week. Domestically, loonie traders are very much focused on tomorrow’s inflation data, which given the focus of the Bank of Canada on the risks of disinflation, will be the week’s main event. The Big Picture: The Bank of Canada remains cautiously optimistic on the Canadian economy but dropped its tightening bias in 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; while the level of exchange rates is not explicitly within the mandate of our Central Bank, the value of the Canadian Dollar is now implicitly in the crosshairs of Governor Poloz as possibly the only mechanism for stimulating economic activity without further burdening the household sector. The Bank went as far as explicitly referencing Canadian Dollar strength as a problem in its most recent Monetary Policy Report. Interestingly, the Governor has 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 near 10% in the past 12 months and we expect it to continue an orderly and gradual decline in 2014.

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