Canadian Dollar's April Showers Could Lead to May Flowers

The Canadian Dollar fell across the board last week on a combination of housing market jitters triggered by rising mortgage arrears and the imposition of a tariff on Canadian softwood lumber by the US.

But are these declines warranted given signs the economy is growing in other areas?

The weakness was overdone, thinks Avery Shenfield, an analyst at CIBC Capital Markets.

Shenfield thinks traders should be focusing on the expected 4.0% rise in real GDP in Q1 rather than unsubstantiated concerns regarding housing and lumber.

“Nobody was asking about recent growth figures that have Canada headed for a 4% real GDP pace in Q1, against a paltry 0.7% US result,” said Shenfield in a note seen by Pound Sterling Live.

If so, does the recent decline offer a perfect buying opportunity with April flowers leading to ‘May flowers’?

Unfortunately not, says Shenfield, who sees further risks to the Loonie (Canadian Dollar) still crouched on the horizon.

“There’s one more event on the calendar that we see as a potential negative for the Canadian currency: the Fed’s meeting in June,” said the CIBC analyst.

If US employment holds up, as seems to be the consensus, the Fed will probably stick to raising interest rates in June.

US GDP could also rebound given it has always underperformed in Q1 due to seasonal factors.

If the Fed raises rates and the Bank of Canada leaves them unchanged as it is expected to do, “a wider rate differential could see the C$ dip a bit weaker still,” said Shenfield.

Lingering concerns about trade and NAFTA could also weigh on CAD, and whilst softwood lumber only accounts for 1.5% of total Canadian exports there is still a risk of the US imposing a “border tax” despite the chances diminishing substantially, or raising tariffs.

Unlike Shenfield we see it as unlikely the US will impose a blanket border tax as this would push up the Dollar too much and the administration is actively trying to bring it down.

What is more likely is a sort of precision piece-meal approach, as noted by HSBC’s David Bloom in his bearish analysis of the Dollar, which is exemplified by the singling out of softwood lumber for a tariff and the report on currency manipulators commissioned by the

Trump government, since this is unlikely to lead to excessive Dollar-appreciation.

CAD’s quality is expected to shine through longer-term, however, with Shenfield arguing that once the June rate hike is out of the way the Loonie will begin to recover.

“After that final hurdle (June hike), our base case has the loonie regaining some of its recently lost ground. By year end, the Bank of Canada will be openly hinting at rate hikes here for early 2018.”

He also sees increased employment growth supporting healthy mortgage and credit data, and Canada “reaching some sort of accommodation,” on softwood lumber as “past precedents suggest” and in line with comments from the Canadian minister for foreign affairs who said she was confident such a deal could be reached.

CAD should then rise ending the year a couple of cents stronger.

“That’s the base case, with the C$ regaining a couple of cents by year end. But it doesn’t make the loonie a screaming buy. If the C$ does see a big move this year, the risks are to the weak side,” concluded Shenfield.