How closely is the Canadian dollar’s recent strength tied to the runup in crude? What are the other key global risk factors in play and where will the loonie be at year-end? In an e-mail discussion, David Parkinson asks three experts to weigh in.
DAVID PARKINSON: This latest rally in the Canadian dollar, this return to par with the U.S. dollar – is this basically on the back of oil prices?
BENJAMIN REITZES, senior economist, BMO Nesbitt Burns: While oil CL-FT has certainly been one of the factors … it’s not the only one. Since mid-December the loonie has been rallying as markets became somewhat less concerned that Europe is going to implode. Also, the Federal Reserve’s announcement on Jan. 25 that rates are going to stay “exceptionally low” until late-2014 has weakened the greenback, benefitting the Canadian dollar.
CAMILLA SUTTON, chief currency strategist, Scotia Capital: Since the end of 2011, CAD [Canadian dollar] has rallied over 2 per cent, while [West Texas Intermediate] oil prices have rallied an impressive 7 per cent. However The short-term correlations between oil and the Canadian dollar have turned negative, suggesting that the two assets are not moving in tandem. I would agree with Benjamin, and argue that the rally in the Canadian dollar has been on the back of a general risk rally fuelled by global central bank policy and a better outlook for the U.S. economy.
The geopolitical rally in oil prices has a mixed impact on Canada; it is positive for the oil exporting side of the economy, but weighs heavily on the U.S. economic outlook.
DAVID MADANI, Canada economist, Capital Economics: I think the Canadian dollar rally, which began before the recent uptick in oil prices, has more to do with the better tone of global economic data and prospects of sustained global economic growth ahead. This view is consistent with the rally in equity markets.
CS: I would suggest above all else, A triple-A status and developed bond market make Canada (and our dollar) an attractive investment. A stronger U.S. economy is also positive as is the central-bank-fuelled risk rally. However, recurring spikes in risk aversion are likely to slow a strong Canadian dollar trend. Our market appears to have tunnel vision on Europe. Geopolitical risks in Iran are bubbling and are a clear risk.
Curious what you think the other risks are to the Canadian dollar. For me it is oil, China, European growth …
BR: Agreed. Europe is still the primary risk, though it appears to be dissipating for now. The potential for a hard landing in China and the resulting impact on commodities would be a negative for the loonie as well. The picture is muddled with respect to oil. High prices will support the loonie in the short term, but the resulting slowdown in global growth will act as a restraint on the currency beyond the short term.
CS: One of the interesting pieces for risk is how volatility has behaved. It feels like there is lots of risk looming, but we have volatility at notably low levels in both equities (the VIX) and currencies... This suggests the market is relatively complacent and likely believes in the commitment by policy makers (mainly central banks) to step in and support the recovery (and markets).
Central bank policy is interesting. If the Federal Reserve does stay on hold until 2014, it puts the Bank of Canada in an odd place. However, I would argue that the Bank of Canada grows increasingly eager to shift rates away from emergency levels and begins to hike rates in 2013. This is more of a medium term story, but I still see it as supportive of the Canadian dollar.
