Turmoil continues to be the common denominator in today’s global financial markets. The foreign exchange (FX) markets are no exception. In fact, the currency market is the most bearish on the EUR that it has been in the past seven years, due to concerns that European banks and economic growth will face challenging times as they weather European sovereign debt issues. Asian currencies, although performing relatively well, appear to be under the influence of the saber-rattling between North and South Korea as well as the uncertainly of global economic growth. The Middle East concerns have now been elevated after the Israeli commando raid on the ships carrying aid to the Gaza Strip. In the meantime, the U.S. is trying to figure out how to stop its shores from being covered in tar balls and trying to spur its own growth and job creation, while it accumulates a $13 trillion debt.
However, if you are looking for a place where things appear a bit brighter, a place where the summer sun shines a little longer, we only need to look to our neighbors to the north. It seems Canada has weathered the storm and is poised to lead in the global recovery. Last week, the Bank of Canada (BoC) was the first of the Group of Seven (G7) economic powers to raise its key interest rate. It was the first increase since July 2007. The target rate on overnight loans between commercial banks now stands at 0.5 percent, up from 0.25 percent. The process of moving rates higher is under way and additional increases are in the pipeline this year. Yet, BoC added they would allow plenty of policy leeway, saying "given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments, against future growth in Canada and elsewhere." The bank said Canada's growth has been expected, while the global recovery is "increasingly uneven."
To many, the Canadian domestic economy continues to impress as it recovers faster than expected. Canada's output grew at a 6.1 percent annualized pace, twice that of the U.S. in the first quarter, while the central bank forecasted inflation will exceed its 2 percent target over the next year. Canada has benefited from rising demand for copper, gold, wheat and oil from emerging economies such as India and China. The country is the world’s second biggest exporter of natural gas and sits on the largest pool of oil reserves outside the Middle East. Private companies led a gain of 108,700 jobs last month — the largest on record dating from 1976 — and the unemployment rate fell to 8.1 percent from 8.2 percent. This job growth is supporting retail sales, which set a record high in March according to Statistics Canada. The Bank of Canada said in April that inflation will be higher than its 2 percent target in the next year. Inflation accelerated to 1.8 percent in April from 1.4 percent in March.
In addition, Canada ran a narrower-than-expected deficit in the fiscal year that ended March 31 as revenues increased more that thought. Faster-than-expected growth suggests the current Canadian administration will have more leeway to reduce its record deficits. The government last month revised its forecasts for growth, implying Canada's economic output this year will be more than projected. Within the global recovery story, Canada appears to be fairing the best among developed nations given its healthy fiscal and financial condition heading into the recession. Moreover, Canada's status as a major commodity-exporting nation has helped it to capitalize on the demand for energy and metals among emerging Asian markets, which did not suffer as much from the global downturn.The CAD
Canada's dollar has only weakened slightly against the U.S. dollar in the past few months. This recent pullback was mostly due to risk aversion amid concern the sovereign debt crisis in Europe may hamper the global economic recovery, driving investor to the USD and Japanese yen as safe havens. However, the CAD is still one of the best performing currencies over the past year. The strength of the currency reflects the success of the economy — in some regard a victim of its own success. The risk is a stronger currency makes the country’s exports less competitive. The value of the CAD remains closely tied to overall risk sentiment and commodity prices, both of which will remain fairly firm the medium term, near-term pullbacks notwithstanding. (See the nearby graph showing the correlation between the value of the CAD and the price of oil). Source: Bloomberg
Together with the backdrop of supportive cyclical strength and rate hikes, I think the CAD will remain strong with the possibility of extending beyond parity again. Also, judging from the most recent commentary, Canadian officials have been less hostile to CAD strength, encouraged in part by the strength of the recovery and commodity prices. In addition, the CAD could potentially be supported as growing reserve currency. The Canadian bond market ranks fifth in size among reserve currencies, behind the U.S., Japan, euro and the UK. With reserve managers looking to diversify their portfolios due to global fiscal developments, Canada may make sense as a diversification play. Further out, there is risk of a possibility of a broad U.S. dollar recovery against the CAD, as more sustainable U.S. growth and USD supportive capital flows develop, which will affect the CAD given Canada is the largest trading partner of the U.S. In the meantime, follow the stars north. The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
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