Canadian Dollar Draws More Calls for a Rebound as Strategists Eye Oil Prices, Economy

-National Bank of Canada forecast 7% upside for the Loonie.

-J.P. Morgan strategists eye Loonie as a "potential buy".

-NAFTA progress the required catalyst for a rebound. 

© moonrise, Adobe Stock

The Canadian Dollar drew new members Wednesday to a choir of economists and strategists who are now looking for a rebound from the currency, which has been the developed world’s worst performer against the US greenback in 2018.

Canada’s unit is down by 2.5% against the US Dollar for the year to date, which is a steeper fall than those experienced by the beleaguered Australian Dollar and Swedish Krona, both of those being the only other G10 currencies to cede ground to their US rival this year.

The move comes against a backdrop where the Bank of Canada has matched its southern neighbour by raising interest rates on one occasion thus far in 2018 and where prices of crude oil, Canada’s largest export, have continued their ten-month long climb. Prices for West Texas Intermediate, North America’s main benchmark, have risen by 52% to $64.67 since June 2017.

“Having depreciated more than 2% against a tired USD, the loonie is among the worst performing major currencies this year. And that is despite the pick-up in world oil prices,” says Krishen Rangasamy, an economist at National Bank of Canada. “The Canadian dollar has never been that weak when WTI oil is near $65/barrel.”

Much like the rest of the analyst community, Rangasamy attributes the Canadian Dollar’s weakness to recently-elevated fears over the future of the North American Free Trade Agreement, which is being renegotiated at the behest of US President Donald Trump who once described it as “the worst deal in history” while out on the campaign trail. The White House threatened to withdraw the US from NAFTA if more palatable terms cannot be agreed.

Markets became more concerned about whether the deal could be renegotiated through February and March as talks continued without progress and the White House’s rhetoric on international trade more generally, took a hawkish turn. President Trump announced a series of new trade tariffs in March and has committed targeting the Chinese directly over alleged intellectual property theft.

Some analysts have previously suggested the Canadian Dollar could fall as much as 20% if the US walks away and they might be right as the 2.6% 2018 rise in the USD/CAD rate comes against a -5.7% fall in the broader US Dollar index and the US hasn’t actually withdrawn from the pact yet. Negotiators will have one last round of meetings in April to seal a deal before talks are placed on hold pending Mexico's Presidential election and the US midterms in November.

“The impact of unfavourable Canada-U.S. interest rate spreads continues to dominate and suffocate the loonie. The real spread is indeed the most negative since the summer of 2015,” says Rangasamy. ”Back then, there were concerns among investors about Canada’s ability to overcome the oil price crash. This time, the fear factor seems to be more about NAFTA renegotiations, the housing market (due to B20 regulations) and the sustainability of consumption growth (due to the heavy debt load of households), all of which are hurting spreads and hence the Canadian currency.”

However, Rangasamy and the National Bank of Canada team forecast that, if this so called fear factor fades away over the coming months, the USD/CAD rate will fall back to 1.20. This would be a 7% drop from the 1.2901 level that prevailed during noon trading in London Wednesday, though it’s not only the National Bank of Canada team who are biding their time and waiting for an opportunity to bet on a resurgent Loonie.

Strategists at Skandinaviska Enskilda Banken (SEB), one of Europe's top 20 lenders by market capitalization, also forecast this month that USD/CAD will fall to 1.20 as trade concerns die away and markets return their focus to Canadian economic fundamentals and monetary policy. Others too are beginning to eye the Loonie with a view to betting on a turnaround. 

“CAD is on our watchlist as a potential buy once decibel levels around protectionism ebb,” says Arindam Sandilya, executive director of foreign exchange strategy at J.P. Morgan, in a recent note. “Press reports this week suggested a major American concession in NAFTA discussions on the US content of auto exports from Canada and Mexico, which ought to shrink part of the sizeable risk premium in the currency, while inflation now running above target in both core and headline will cap the amount of dovishness the BoC will feel comfortable delivering.”

Sandilya and the J.P. Morgan team identify another factor that may help buoy the Canadian Dollar if and when concerns over NAFTA fade away. Canada's inflation rates rose much faster than was expected during February, putting the headline level of consumer price inflation at 2.2%, which is above the Bank of Canada's 2% target.

Moreover, all of the BoC's so called "core measures" of inflation, which remove volatile items from the goods basket, also hit the 2% threshold or came to rest a touch below it. This is something that, in ordinary times, might have been enough to get markets betting on further interest rate rises during the months ahead, which would be positive for the currency. 

The Bank of Canada raised its interest rate by 25 basis points to 1.25% in January. At the time markets were happy betting the central bank would manage a total of three interest rate rises in 2018 as a whole but since then, interest rate derivatives markets have become less convinced and are now pricing just one more rate rise for 2018. This could soon change if negotiators strike a deal in April or hopes of an agreement further down the track are firmed up at the next round of talks. 

The USD/CAD rate was up by a fraction at 1.2901 during noon trading in London Wednesday while the Pound-to-Canadian-Dollar rate was 0.50% lower at 1.8165.

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