The Canadian dollar is undoubtedly a commodity currency and its largest export by far is crude oil. So why is oil at a 10-month high and the Canadian dollar at a 5-month low?
Here are some of the things dragging down the loonie:
- Worries about global growth — predominately in China — weighing on commodity demand later
- Fear that a bubble in Canadian home prices is bursting
- Expectations that the Bank of Canada won’t hike rates this week and could be relatively quick to cut
- Signs that the Canadian economy is cooling rapidly, including a negative Q2 GDP print on Friday
- Canada is a poor place to do business so despite high oil prices, there’s little inbound investment in its massive reserves
Add it up and the US dollar hit a 5-month high against the loonie today before backing off.
There’s no doubt that a uniquely strong US dollar is also part of the equation as Treasury yields rise on the belief the US will hold rates higher for longer.
The next move in the Canadian dollar will be dictated by tomorrow’s Bank of Canada decision.
There was once a large contingent of Canadian economists calling for a September hike and the market priced a high chance it would come but as the data has rolled it, that’s dwindled. The market now sees only a 6% chance of a hike on Wednesday and that peaks at about 40% by year end.
Given the low odds of a hike, the market reaction will depend on signaling on future rates. There’s a good argument that the BOC should announce a halt to rate hikes and a firm neutral stance but that’s unlikely to happen. The main reason is that they did that in February and were later forced into an embarrassing climbdown and a hike in June (that later proved to be unnecessary). It’s part of a series of missteps by BOC Governor Tiff Macklem. That mistake is likely to lead to higher rates for longer, which in turn will lead to a harsher housing drop than necessary.
What worries me is that high US rates and a misguided Bank of Canada leave rates too high as the economy rapidly decelerates on dampened consumer spending. That would be in part due to fears about a falling Canadian dollar and imported inflation.
That’s not an easy call but I think the BOC will opt for higher rates in tandem with the US despite diverging economies. The problem is that the market won’t be fooled forever and the US dollar is a freight train right now.
Zooming out further on the chart, there’s plenty of room to the upside before any real pain.
I’ve been calling for USD/CAD strength for awhile and all the recent data confirms that it’s coming. If the BOC shows some wisdom and shifts to neutral then it could come on Wednesday but that’s a lot to ask from this version of the BOC.
This article was written by Adam Button at www.forexlive.com. Source