August 20, 2021 | 13:14
Lazy Days of Loonie
In a generally downbeat week for financial markets, the Canadian dollar was one of the biggest downers. After setting sail on Monday at just below 80 cents (or just above $1.25/US$), the currency promptly tacked hard all week long to nearly a 3% loss, hitting 77.5 cents ($1.29) Friday morning. The currency is now down roughly 1% since the start of 2021, after soaring as high as 83 cents less than three months ago. A wide range of factors conspired against the currency, although all its commodity cousins were also walloped this week, so the main drivers weren’t necessarily domestic in nature. In rough order of importance (and some are clearly inter-related):
1) A dimmer global outlook: The ongoing spread of the Delta variant continues to chip away at the global growth backdrop. Whether it’s by putting new kinks in supply chains, prompting new lockdowns, or curbing consumer enthusiasm (especially for travel), the latest wave is dampening activity. Compounding these concerns is the broadening regulatory crackdown in China, as well as clear signs of a cooldown in that critical economy. After all, the week started there with notable misses on both retail sales and industrial production for July, with the latter actually grinding lower in recent months. To the list of global dampeners, we have to add the sorry developments in Afghanistan this week; while obviously not a big contributor to world GDP, the ultimate failure there creates another potential geopolitical flashpoint, is yet another weight on sentiment more broadly, and will at the very least split policymakers' attention.
The less ebullient global growth outlook has supported haven demand, benefiting Treasuries and the U.S. dollar. While the former didn’t make a huge move this week, 10-year yields still drifted lower through most of the week to 1.25%, down more than 50 bps from the March highs. At the same time, the U.S. dollar index pushed to its highest level in nine months. On the flip side of the greenback’s gains, the Canadian dollar tends to thrive during periods of strong global recovery, but dive in times of global concern.
2) Weaker commodity prices: One of the biggest financial market victims of the Delta variant has been commodity prices. In particular, oil has been hit hard by the prospects of a slower return to normal, with WTI sagging more than $10 just since the start of August to $63. Natural gas prices have also receded somewhat from their recent highs above $4. The pullback in energy prices follows an earlier big retreat in some of the other high-flying commodity prices. The Bank of Canada’s ex-energy commodity price index has now pulled back 17% from its May peak (with lumber the biggest mover), although it is still clinging to a 3% rise since the start of 2021. Resource prices ebb and flow as a driver of the loonie, but ultimately are critical to the currency’s fate. But note that even with the recent drop, the BoC’s overall commodity price basket is up about 20% since the start of the year, while the currency is down slightly over that period. So, there’s more at work than just softer commodity prices.
3) Taper talk: While there was little shock in the most recent FOMC Minutes for the late-July meeting, markets were a bit surprised at the mildly aggressive taper discussion. The new news was that a small majority appeared to favour tapering to commence before the year ends. Of course, we can’t know if the “majority” includes Chair Powell; and recall that there are many (hawkish) voices in the regional banks who don’t always get a vote. So while the odds of a slightly faster tapering have risen, it will of course depend heavily on the next jobs report (or two), as well as coming inflation readings and just how deeply Delta dents real activity. Still, the Minutes fired up the U.S. dollar, and the loonie’s skid gathered some serious momentum in the aftermath. The irony is that the BoC has been busily tapering its own QE for months now, grinding it from as fast as at least $5 billion/week to $2 billion now—in proportion to the size of the economy, that’s now less generous than the Fed’s program ($3 billion/week by the BoC is of roughly similar size to the Fed’s $120 billion/month).
4) The Federal Election: While Canadian elections don’t tend to make big lasting waves in financial markets, they can send ripples. And any uncertainty tends to be expressed most particularly in the currency market, perhaps contributing slightly to the loonie’s volatility. This week began with the election officially set for September 20 (just one month away!), and some polls tightened slightly. One quick curve ball right away was the surprise result in Tuesday’s Nova Scotia provincial election, where the Progressive Conservatives won a majority, upsetting the ruling Liberals—even as the latter began the campaign with a healthy poll lead. While it’s unlikely that such a dramatic flip-switch could happen to national sentiment, it’s not impossible, so markets will be spying the polls a bit closer than normal. (This week’s Focus Feature looks at the major policy proposals of the three biggest parties.) One footnote on the election results: The Chief Electoral Officer suggested this week that it could be days after the vote before the results will be finalized this year, owing to the possibility of millions of mail-in ballots (which will only be counted after the vote).
5) Thin markets: A wise person once said: “Never change your fundamental forecast in August”, since markets can send misleading signals in the depths of summer. With many key participants on vacation and/or perhaps not as fully engaged as normal, market moves can be exaggerated. Keep that in context amid the fast fall in the Canadian dollar, and some of its key commodity counterparts. Note that the Australian dollar was also clipped by 2 cents this week, with the RBA sounding a tad less hawkish and amid another wave of lockdowns there. And the slide in the Aussie was in spite of a surprisingly decent jobs report, which included a drop in the jobless rate to just 4.6%, its lowest ebb since 2008. It was a broadly similar picture for the New Zealand dollar, as it fell more than 2 cents on the week to around 68 cents; the big weight there was that the RBNZ kept interest rates steady against widespread expectations of a first rate hike among major central banks. Local lockdowns on a small Delta outbreak prompted the cautious turn.
Where do we go next? The Canadian dollar may well remain on the defensive as long as Delta continues to rage and likely through the election campaign (and maybe a few days longer, as noted above). However, our one-year view still looks for the currency to firm moderately to around the 82-83 cent level (about $1.21). The main driver is expected to be a more complete global recovery, supported by a somewhat earlier tightening by the Bank of Canada versus the Fed.
Notably absent from the list above on weights on the loonie is any mention of domestic economic data. In fact, the news was generally positive, flattered by the mid-year economic reopening. The one big surprise happened to land on the most important indicator, as CPI blew through expectations with a 3.7% y/y rise. That may pale next to the 5%+ readings stateside, but it was still the fastest Canadian inflation rate since 2003 and about 3 ticks above expectations. And that may well be an understatement of reality since it doesn’t include used cars (up more than 40% in the U.S.), while the reported 13.8% rise in home prices is probably a bare minimum. The CPI measures new home prices, and while they are running at their fastest clip since 1987, they are still trailing well behind increases in existing home prices (up 22% in July).
The hot inflation reading even intruded in the election campaign. Asked if he may favour a more flexible inflation mandate for the Bank of Canada, the Prime Minister offered: “When I think about the biggest, most important economic policy this government, if re-elected, would move forward, you’ll forgive me if I don’t think about monetary policy…” Requiring every ounce of willpower necessary to remain neutral, we will note that, from a practical standpoint, this statement suggests that there are unlikely to be any huge shifts in the current five-year mandate review for the BoC.