Expected USD/CAD Range: 1.105 – 1.111 Update: The crisis in Ukraine is impacting the markets in a substantial way for the first time. Energy prices are up (oil: +2.5%), equity markets are trading down and there is a general push into safer assets. In the currency market, almost all emerging market currencies are impacted, especially the Russian ruble which is down around 10%. Major currencies considered safe-havens like the US dollar and the Japanese yen are trading up. The Canadian dollar is an interesting position. On the one hand, higher oil prices and relative stability would suggest the loonie should be slightly stronger. But as we have seen time and time again in times of geopolitical stability, the flows into the US dollar overwhelm any perceived safety seen in our currency. Making the picture even more murky, raw material and industrial price indices that came out this morning suggest that the disinflation fear is quickly receding, removing the primary rationale for a dovish posture by the Bank of Canada. The net result is that the loonie is weaker by 0.3% relative to last Friday’s close. 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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