Canadian Dollar Falling Like a Leaf

The Canadian dollar is the most detrimental performing major currency over the past month.  It has lost over 3.5% against the US dollar.  That brings its year-to-date loss to almost 12%. 

There have been two main sources of pressure on the Canadian dollar.  The drop in oil prices poses a negative terms of trade surprise on the economy. While below normal conditions, we usually emphasize factors that change up the capital markets over the items markets when assessing the outlook for a major currency.  This is especially true of a reserve forex. However, the magnitude of the decline in oil costs, and the fact that various parts of the Canadian economy seemed leverage to high oil prices requires adjusted our analytic framework. 

The second factor that has pressured the Canadian dollar is the Financial institution of Canada's monetary policy.  The January rate cut was a surprise.  Last month'utes rate cut was much less surprising, but the dovishness of the main bank was unexpected.  Financial institution of Canada Governor Poloz not only kept the door open to additional easing but also put QE on the table for the first time.  To be sure, expanding the central bank's balance sheet had been cited in the context of a range of choices that the central bank might adopt if necessary.  It was obviously not a commitment to do so at this juncture. 

Canada surprised investors before the weekend by reporting the economic contraction that was evident in Q1 has spilled more than well into Q2.  The May GDP unexpected contracted 0.2% after a 0.1% contraction in April.  According to the monthly Gross domestic product estimate, the Canadian economic climate expanded only in one month since last October, which was the 0.4% growth in December 2014. In contrast, observe that the Q1 contraction in the US has been revised away (now +0.6%) as well as Q2 expanded by 2.3%.  The actual divergent economic performance is mirrored in the expected divergence of the trajectory of monetary policy. 

To these macroeconomic considerations, we must add a third element.  Prime Minister Harper has called for elections.  It will be held on October 19.  Although the US presidential election is not until November 2016, it is already underway.  Some would say it began the day after the 2012 election.  By Canadian standards, this is a long campaign period, the longest in modern Canada history. 

The reason it is unfavorable for the Canadian dollar is that it boosts uncertainty over coverage.  Harper is one of the longest serving Prime Ministers in Canada.  He has went after a conservative agenda.  He cut government and taxes.  Harper's policies have generally been perceived as pro-business and friendly for investors.  The latest forms (from July) show Harper's challenge.  His Conservatives are trailing in the polls 31.Six to 32.6 for that left-of-center New Democrats.  The NDP suddenly won the local election in Alberta, one of the most conservative provinces.  The centrist Liberals are polling around 25%.

In the last election (2011), Harper's Conservatives won 166 seats in the 308-member House of Commons. Nevertheless, new constituencies have been formed and in new the House of Commons there will be 338 seats.  Harper formed a majority government this year, but this was an exception.  The last three elections (one led by the Liberal Paul Martin and the other two by Harper) produced group governments.

In response to the stop by oil prices and information that the economy contracted within May, the US dollar posted an outside up day (exchanged on both sides of the prior day's range and closed above the previous day's high) before the weekend against the Canada dollar.  There has been follow through purchasing of the US dollar against the Canada dollar since investors were able to respond to the election statement.  The US dollar is at new multi-year highs.  To the extent which resistance denotes where (US dollar) supply may come in, technical levels may not be particularly helpful.  We have suggested the next objective is near CAD1.3450, and see potential toward CAD1.40 over the long-term. The upper Bollinger Band set from two standard deviations above the 20-day moving average is close to CAD1.3200.

Three Strikes Against the Canadian Buck is republished with permission from Marc to Market