Canadian dollar coins are pictured in Vancouver, Sept. 22, 2011.JONATHAN HAYWARD/The Canadian Press
The Canadian dollar jumped almost a full cent against the greenback last Wednesday after the Bank of Canada announced a surprisingly hawkish monetary outlook.
The move, however, could prove deceiving. Reaction in the currency market to central bank policy has been increasingly hard to detect over the past few years. Instead, the Canadian dollar has become a global reflation trade – tracking the copper price far more closely than fixed income markets or even crude.
And given the copper price this week is retesting record highs of above US$10,000 a tonne (about US$4.50 a pound) last seen a decade ago, the Canadian dollar seems well supported at current levels.
Changes in the loonie price were easily intelligible in the wake of the financial crisis. From 2009 to mid-2018, the currency’s value followed relative bond yields – the difference between the yield on the two-year government of Canada bond and the equivalent U.S Treasury yield – almost exactly.
This time, I haven’t even included a chart comparing relative yields and the Canadian dollar. Over the past three years, the correlation between them has turned negative. More often than not, the loonie has moved in the opposite direction of yield spreads. The premise – that foreign investment would gravitate to Canadian bonds when looser central bank policy allowed for higher Canadian yields relative to Treasuries, creating demand for Canadian dollars – no longer works well.
The petro-loonie thesis that the Canadian dollar will track the crude price has held up better than relative yields in explaining changes in the currency value, particularly over the past 12 months. Where commodity prices are concerned, however, copper has provided the best indicator for the direction of the loonie in recent years.
The first two accompanying charts compare the path of the Canadian dollar to the oil price and the copper price, respectively (I used the West Texas Intermediate crude price because it had a slightly higher correlation with the currency than Western Canadian Select crude).
CAD/USD
WTI crude (US$/bbl, right scale)
$0.83
$90
0.81
80
0.79
70
0.77
60
0.75
50
0.73
40
0.71
30
0.69
20
0.67
10
0.65
0
2019
2020
2021
THE GLOBE AND MAIL, SOURCE:
BLOOMBERG; SCOTT BARLOW
CAD/USD
WTI crude (US$/bbl, right scale)
$0.83
$90
0.81
80
0.79
70
0.77
60
0.75
50
0.73
40
0.71
30
0.69
20
0.67
10
0.65
0
2019
2020
2021
THE GLOBE AND MAIL, SOURCE:
BLOOMBERG; SCOTT BARLOW
CAD/USD
WTI crude (US$/bbl, right scale)
$0.83
$90
0.81
80
0.79
70
0.77
60
0.75
50
0.73
40
0.71
30
0.69
20
0.67
10
0.65
0
2019
2020
2021
THE GLOBE AND MAIL, SOURCE: BLOOMBERG; SCOTT BARLOW
The crude price’s brief but remarkable descent into negative territory a year ago was certainly not helpful in maintaining the correlation with the loonie. Even afterward, however, it appears the domestic currency has led the oil price rather than the reverse. This makes crude an unreliable indicator for moves in the Canadian dollar.
The second chart highlights copper’s role as a far more trustworthy signal for the loonie’s direction. Looks aren’t deceiving – correlation calculations find that copper (three-month future price) has tracked the dollar price 20 per cent more closely than oil over the past three years.
CAD/USD
3M copper (US$/lb, right scale)
$0.83
$5.00
4.50
0.81
4.00
0.79
3.50
0.77
3.00
0.75
2.50
0.73
2.00
0.71
1.50
0.69
1.00
0.67
0.50
0.65
0
2021
2019
2020
THE GLOBE AND MAIL, SOURCE:
BLOOMBERG; SCOTT BARLOW
CAD/USD
3M copper (US$/lb, right scale)
$0.83
$5.00
4.50
0.81
4.00
0.79
3.50
0.77
3.00
0.75
2.50
0.73
2.00
0.71
1.50
0.69
1.00
0.67
0.50
0.65
0
2021
2019
2020
THE GLOBE AND MAIL, SOURCE:
BLOOMBERG; SCOTT BARLOW
CAD/USD
3M copper (US$/lb, right scale)
$0.83
$5.00
4.50
0.81
4.00
0.79
3.50
0.77
3.00
0.75
2.50
0.73
2.00
0.71
1.50
0.69
1.00
0.67
0.50
0.65
0
2021
2019
2020
THE GLOBE AND MAIL, SOURCE: BLOOMBERG; SCOTT BARLOW
If copper provides the asset price most pertinent to investors following the loonie, the Citi Terms of Trade Index for Canada provides the most important economic barometer. The index reflects a weighted average of the price of goods that cross the Canadian-U.S. border.
The terms of trade index is heavily influenced by energy, automotive, machinery and metals prices and provides a proxy for currency demand to facilitate cross-border trade. Higher prices for goods exported from Canada to the United States, for instance, means that American buyers have to exchange more greenbacks for Canadian dollars, helping push the loonie higher in currency markets.
Our third chart shows that the terms of trade index has been an effective indicator for the Canadian dollar. The correlation math points to terms of trade as equally effective as the copper price in tracking the loonie.
CAD/USD
Citi Terms of Trade Index
Canada (right scale)
20
$0.81
15
0.79
10
0.77
5
0.75
0
0.73
-5
0.71
-10
0.69
0.67
-15
2019
2020
2021
THE GLOBE AND MAIL, SOURCE:
BLOOMBERG; SCOTT BARLOW
THE GLOBE AND MAIL, SOURCE:
BLOOMBERG; SCOTT BARLOW
CAD/USD
Citi Terms of Trade Index
Canada (right scale)
20
$0.81
15
0.79
10
0.77
5
0.75
0
0.73
-5
0.71
-10
0.69
0.67
-15
2019
2020
2021
THE GLOBE AND MAIL, SOURCE:
BLOOMBERG; SCOTT BARLOW
CAD/USD
Citi Terms of Trade Index Canada (right scale)
20
$0.81
15
0.79
10
0.77
5
0.75
0
0.73
-5
0.71
-10
0.69
0.67
-15
2019
2020
2021
THE GLOBE AND MAIL, SOURCE: BLOOMBERG; SCOTT BARLOW
Changes in monetary policy by the Bank of Canada will always affect the Canadian dollar, as we learned last week. Governor Tiff Macklem’s recognition that the recovery was proceeding faster than previously forecast and that monetary stimulus could be throttled back as soon as next year sent both Canadian bond yields and the currency higher.
Importantly, however, recent history indicates that the global economic recovery that is driving copper prices higher, and making Canada’s trade-heavy, economically sensitive economy more attractive, has had a more consistent influence on the loonie. For good or bad, I expect that global economic data, and not monetary policy, will remain the primary determinant of the loonie’s path.
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Scott Barlow