With the Canadian dollar hitting a 13-month high of $1.0380 (U.S.) last week – or 96.33 cents to the U.S. dollar – Globe and Mail reporter DAVID PARKINSON held a panel discussion via e-mail with three currency experts, probing what's driving the loonie's rally and where it might be headed next.
- Camilla Sutton – currency strategist, Scotia Capital (Toronto)
- Mark Frey – VP/chief market strategist, Cambridge Mercantile Group (Victoria/Vancouver)
- Adam Cole – global head of FX strategy, RBC Dominion Securities Inc. (London)
DAVID PARKINSON, THE GLOBE AND MAIL: We've just seen a 13-month high for the Canadian dollar (CAD) last week, in the wake of some major monetary-policy-easing announcements from the U.S. Federal Reserve Board and the European Central Bank. Is that at the heart of our rally – the fact that the Bank of Canada looks likely to be raising rates long before most other developed central banks, and the gap keeps getting wider?
CAMILLA SUTTON, SCOTIA CAPITAL: For us, the heart of the CAD rally is threefold: 1) The Bank of Canada's hawkish stance juxtaposed against the Federal Reserve's dovish stance; 2) The success the Federal Reserve and ECB have had in decreasing tail risk and crushing market volatility through the announcement of their very different bond-buying programs (QE3 and OMT [outright monetary transactions]), which have in turn supported a risk rally (equities, oil and CAD); and 3) Canada's Triple-A [debt] rating and strong sovereign status, which has seen significant global appetite in CAD-based investments.
MARK FREY, CAMBRIDGE MERCANTILE: There's no question that [Bank of Canada] Governor [Mark] Carney has been talking a hawkish line for the better part of a year now and that the Fed has been unquestionably dovish, especially of late. That said, while the Fed has surprised the market with its open-ended policy response, there has been very little in terms of actual policy from the BoC to back up the tough talk.… The BoC will likely be constrained by macro factors and global growth concerns from moving forward with any contractionary policy. With this in mind, further divergence from both an interest rate and macro policy perspective is unlikely in the short to intermediate term, thus removing some of the impetus for traders to continue to add to their long CAD positions at this stage.
I would argue that the "buy Canada" story has as much or more to do with our stock of hard asset materials and energy than our triple-A rating itself. Certainly, Canada's strong comparative fiscal situation is a factor here, but the overall macro environment has turned unquestionably bullish on commodities and this has been driving demand for the loonie, and will continue to be a force going forward.
That said, the biggest overall factor the CAD's recent strength in my view is very much in line with Camilla's second point on the extraordinary, non-traditional monetary policy actions of both the Fed and ECB. The market is awash in cheap liquidity and risky assets are very much in vogue. Commodities will be very well supported in this unabashedly pro-growth environment, and traders are getting long risk in anticipation of reflation in asset prices.
However, I think we may be a little bit overbought in the short-term from a technical perspective, though I would expect more of a consolidation in USDCAD than an outright correction.
ADAM COLE, RBC DOMINION SECURITIES: I'd go even further in putting the emphasis on global rather than local factors in driving CAD outperformance – to the point where I think CAD, and USDCAD in particular, has almost entirely detached itself from domestic fundamentals. Of all 45 currency pairs in G10 FX space, none is more tightly or consistently correlated to global risk appetite, and CAD is the markets' revealed "choice" currency for expressing a view on global risk. … So long as the Fed's dials are set to 11, risk assets are underpinned, and CAD is the markets' favoured way of expressing that.
To the extent that there is an element of BoC rate expectations also underlying CAD strength, the above relationship has only been strengthened further by the perception that the BoC's tightening bias is contingent on global more than local factors. I think most would agree, if local factors dominated, last year's BoC tightening bias would have been acted on rather than abandoned.
MF: Domestic fundamentals really don't factor in much at all at present. The Canadian trade figures were disastrous last week and the loonie rallied 50 basis points on the day, with the market showing us very clearly that it doesn't care about the domestic story or data at all. This is a big-picture, event- and headline-driven, macro trading environment where the Fed and ECB are essentially underpinning a massive reflation trade that supports risk and hard assets…
CS: I still struggle with how much strength the Canadian economy can withstand in an environment of decelerating global growth.
Still, currencies are relative stories, and looking at CAD against any of the majors, even in an environment of decelerating global growth, it is clear to see why there is appetite to be long CAD. The Bank of Canada has not turned to alternative policies, the government is stable and has a clear fiscal plan, Canada is rich in natural resources and market sentiment is favourable … Compare this to the U.S., U.K., Europe or Japan and Canada (and CAD) shines.
Bearing in mind that currencies overshoot, what do you think the low in USDCAD is in the next month?
AC: Assuming we get over the risk indigestion of the last couple of sessions, I think we'll see an attempt to break the 0.96 mark [in the cost of one U.S. dollar in Canadian currency], though it will take a substantial weight of good news to keep us there. Do you think the 2011 lows around 0.94 would be too ambitious a target?
CS: Currencies overshoot, so yes, it can go there, particularly if China does succeed at engineering a soft landing (our base case); however, I suspect USDCAD will have a challenging time sustaining itself at or below 0.94 (or above $1.06 (U.S.) in CAD) for long … it is more comfortable a little closer to parity. If sentiment turns and the EUR rally fades, CAD will be susceptible to a violent shift downward as the extreme positioning in net long is unwound.
MF: I would say that we are due for a consolidation, perhaps not an outright correction, that might see us test to the high side in the 0.98 range before we probe lower again. Playing USDCAD from the long side, however, in anticipation of this pullback would be akin to picking up nickels in front of a steamroller … as a subsequent test of the 0.96 level is almost assured, and the 0.9450 and 0.94 levels will soon be coming into range. … While I think there is more downside to USDCAD, I think we may be within a cent or two of the ultimate bottom, and the risk of being long Canada isn't as attractive at this stage.
DP: What, in your view, could derail this CAD rally?
MF: We still see purchasing power parity well north of par for USDCAD, and though that might only factor as a real target in the very long run, I do believe that anything materially below par [for the U.S. dollar] is ultimately unsustainable for the Canadian economy at this stage. Simply put, Canada's productivity gains, which are big long-term drivers of currency valuations, aren't anywhere near supportive of an extended move below par in USDCAD. With this in mind, if we break the 0.94 level and run, I can't see those gains for the loonie being sustained at all.
In the short term, I don't see much that will derail the bullish sentiment for Canada other than a flare-up in Europe over sovereign or banking sector risks. That said, the ECB's "nuclear" response has largely mitigated this in the short term. A significant slowdown in China would have a significant impact, but from the data we're seeing, I think we're headed for more of a soft than hard landing (if you can believe the data or have faith that it is not being overly "managed"). The "fiscal cliff" issue in the U.S. is still months away from being top of mind for traders and is therefore not a short-term determinant, though it looms large in the intermediate term.
CS: I would suggest the biggest risk is geopolitical, particularly something that impacts the price of oil and threatens the global economy; the biggest long-term risk is the impact of untested alternate monetary policy on the economy, namely inflation, and finally the biggest near-term risk is a further deterioration in global growth, namely from China. Any or all of these developments would threaten the outlook for CAD.
(This transcript has been edited and condensed for publication.)