The strongest currency among the top 10-traded currencies last year and again the strongest since the start of the 2nd half of 2017. Last week’s rate hike to 1.00% was the 2nd of the year, which reverses the two emergency rate cuts of 2015, delivered against the impact of sub$30 oil.
And so the question becomes the following: Does last week’s rate cut present a normalisation of monetary policy or is it the start of a more prolonged tightening policy cycle? The answer from the Bank of Canada would be to wait for the data. My expectation is that there is room for one more rate hike this in late Q4 or early Q1.
No Currency Worries?
The Bank of Canada faces uncertainties from the US (its largest trading partner) such as the future of NAFTA and the US debt ceiling. The loonie’s 9% appreciation against the USD so far this year may also present challenges for exporters, but the central bank explained the strength as a reflection of the economy’s growth differential with the rest of the world, which is another way of stating that currency strength is valid. And when comparing the CAD to the currencies of Canada’s other 2 major trading partners, China and Mexico, CAD is up 4% vs. CNY and down 5% against MXN.
Canada’s structural strength is also helping the currency stand out from the rest. A budget deficit of less than 1% of GDP compares with 3.7%, 2.4% for the US and UK respectively. This has enabled Ottawa to deliver tax cuts last year, something that no major G5 nation could contemplate due to their deteriorating fiscal balances.
The charts below highlight how the Canadian can take advantage of the best of both worlds; USD weakness and oil stabilisation. The 2 graphs indicate the rally in CAD vs. USD accelerated notably while US Crude oil consolidated under $49. But any corrective rebound in the US dollar may not necessarily imply a rapid decline in oil prices as long as the general commodities picture remains positive.
USDCAD may recover to 1.2400 as part of the Fed’s efforts to signal the start of selling its bond portfolio, but I expect that by end of this year, traders will be more concerned with 1.17 than 1.27.