One of the big surprises for the year was the sharp slide in the Canadian dollar to an extent that far transcended the last leg of the decline in oil prices.
An 80-cent (U.S.) Canadian dollar was supposed to be the panacea in terms of providing the thrust to the manufacturing sector and exports that would have provided the much-needed antidote to the collapse in the energy patch. But if that were to be case, Canada would not have endured a mini-recession in the first half of the year. Nor would the loonie have sunk to as low as 74 cents, undercutting the 2009 global recession low.
So when I was asked in recent months where the Canadian dollar would bottom out at, my answer was "I don't know what that exact level is going to be, but I do know the conditions that will prevail when that low is turned in."
Well, those conditions have arrived – finally! Here are the reasons to turn more constructive.
The factory and export data Our current tracking for third-quarter real GDP growth has Canada growing at 2.7 per cent annually and the U.S. near 2.5 per cent – a rare quarter of outperformance for the red and white.
But what is key is that, finally, the cheaper currency has triggered a manufacturing revival.
The three-month trend in durable goods manufacturing shipments is 22 per cent when annualized (13 per cent in volume terms) and orders have soared 135 per cent (yes, that is the case; it is a more modest increase of 26 per cent in real terms).
Even with the August setback, the recent run of export data had been so strong that three-month annualized pace in outbound shipments has surged 19 per cent (and that again is almost purely volume growth, with real exports up 16 per cent).
Industrial output has soared at a 6.2 per cent annual rate over the past three months (more than triple the 1.9 per cent growth for the U.S.; my, how the tables have turned).
This is the rebalancing the Bank of Canada has long been seeking.
The technical picture has improved The Canadian dollar has successfully pierced its 50-day moving average of $1.3194, or 75.79 cents U.S., and is now poised to test the 100-day moving average of $1.2875 (77.66 cents). The resistance after that is $1.2610 (79.30 cents).
Valuations have improved substantially A forecasting model used by the Bank of Canada that we've modified suggests fair value near the $1.27 level, or 78.74 cents U.S. Meanwhile, the Economist's Big Mac index – a purchasing power parity measure based on the price of a Big Mac in U.S. dollars – pegs it at $1.22, or 81.96 cents U.S.
Either way, more to go.
Commodity prices Oil prices used to have an 80 per cent correlation with the loonie and now it is a 94 per cent relationship.
Oil looks to have not just carved out a bottom but is visibly basing – the U.S. production and inventory data have finally become supportive.
Bank of Canada policy The Canadian central bank has become less dovish while the U.S. Federal Reserve has become less hawkish and so the gap between two-year Canada government bond yield and two-year U.S. Treasury yield has narrowed from 34 basis points recently to 10 basis points.
Housing I suppose it is reasonably safe to assume that the long feared real estate meltdown has proven to have been a very bad call by the hedge funds – given home sales are up 4 per cent over the past year, building permits up 13 per cent and housing starts up nearly 11 per cent over the past year.
Either that, or it is something that will ultimately come down the road if we just wait long enough.
Competitiveness While unit labour costs are growing at the same rate in both Canada and the U.S. at 1.7 per cent year over year, the Canadian dollar has become so competitively supercharged that in U.S. terms, those same costs north of the border are down about 10 per cent year over year and the level, as well as this trend, is back to mid-2009 levels – when the loonie also picked up from a deep bottom.
When previous Bank of Canada Governor Mark Carney was driving the Canadian dollar ever higher and above par four to five years ago, domestic unit labour costs in currency-adjusted terms were rising 9 per cent at a time when the comparable U.S. trend was running flat.
Not surprisingly, that is when the hollowing-out effect for Canadian industry started – but thankfully, is now far behind us.
Foreign direct investment Believe it or not, global companies are starting the process of reinvesting in Canada in a "bricks and mortars" sense – actually raising their stake in Canadian industry by 60 per cent over the past year.
But Canadian companies have actually been the ones moving productive capacity out of the country – by a factor of nearly five.
If domestic businesses ever start to look at Canada as positively as foreign companies appear to have become, this could be a very powerful source of strength for both the economy and for the currency.
Market positioning Sentiment is so bearish that there is still a 43,056 futures and options net speculative short position on the Canadian dollar on the Chicago Mercantile Exchange.
That has come down in recent weeks so we are seeing early signs of a short-covering rally – and the hedge funds have not been net long since May 26th when the Canadian dollar was sitting at $1.23 (or just over 81 cents in U.S. dollar terms).
The politics The aggregation of the latest polls show the Conservatives and the Liberals in a dead heat at around 33 per cent of the vote, but the regional split is such that it implies a PC minority (126 seats to 118 for the Liberals, 92 for the NDP and one each for the Bloc Québécois and the Greens). We know from history that pro-market governments tend to be more welcomed by currency traders.
All roads lead to a firmer loonie … until otherwise notified!
David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.