It seems to have been a while since we examined what is happening with the Canadian dollar (CAD). The CAD — affectionately known as the loonie after the bird that is on the back of the one dollar bill — is approaching parity with the US$. The question that is inevitably being asked: How strong will it get?
The Canadian dollar has a very different relationship to the U.S. dollar than other currencies. If we make the assumption that economic factors are stable in Canada, when the U.S. economy is improving the Canadian dollar will strengthen against the U.S. dollar while other currencies lose value. The reason for this reaction is that the Canadian economy is so reliant on the U.S. that if the U.S. is doing well, it helps the Canadian economy and consequently the Canadian dollar.
One of the most significant retail factors is oil. Canada is the largest exporter of oil and natural gas to the U.S. If U.S. consumer confidence were to pick up, the ability of the U.S. consumer to buy more oil would be expected to increase, causing the Canadian dollar to increase in value against the U.S. dollar.
In what we might term as the normal economics of two years ago, the above scenario would have occurred. In today's economic environment, things seem to be normalizing and the above assumptions should still hold true. In the last two months as oil has traded either side of the $80 level, the Canadian dollar has strengthened 3 to 4 percent. Under normal circumstances one would assume the rise in oil was caused by more demand. This was part of the reason, while the other contributor to the higher price was speculation. We know demand is slowly picking up as the amount of oil stored in tankers is starting to decline. With seasonal demand expected to increase as we go through summer, the supportive potential of energy to the Canadian dollar seems good.
Investment in Canada is the other main factor that often helps the Canadian dollar. With the U.S. benefiting from a lot of fear-driven investment as negative news about Greece and sovereign debt levels cause intermittent flight-to-safety in investments, the funds flow to U.S. Treasuries. You may ask how that helps the Canadian dollar. When investors who buy U.S. Treasuries look at the amount they have in their portfolios, they find they need more diversification. Canada becomes the proxy U.S. investment. This was well demonstrated last week. The Treasury International Capital flows for January, which measured investment in the U.S., showed a huge decline. Meanwhile, the international investment data for Canada that came out a couple of days later for the same time period showed a small increase. One month is obviously not a good indicator, but over the last 18 months we have seen this occur on a number of occasions. In those instances, after there had been large capital flow into the U.S., the following month Canadian incoming investment increased.
If we look at the correlation of the Canadian dollar and oil, the low for the USD/CAD was set on November 7, 2007 at 0.9058 when oil was at $90.72. The high since then was 1.3065 set on March 9, 2009 when oil was at $ 48.83. Technically, the long-term moving averages last crossed at 1.1927, indicating a stronger CAD trend. The short-term moving averages last crossed at 1.0607, also indicating further strengthening of the CAD.
Interest rates in Canada are tending to mimic those in the U.S., but recent comments from the central bank suggest that it may embark on the tightening cycle ahead of the U.S. — yet another supportive factor for the currency.
Most of the above assumptions are based on the more positive recent U.S. data. However, if data turns negative and concerns grow over the potential market impact of the health care bill, the USD may strengthen as a result of flight to quality. Potentially, oil would be sold off with other commodities as the U.S consumer optimism would be expected to retreat causing the CAD to lose value.
I will be surprised if the Canadian dollar does not touch parity with the U.S., but in these times when news examples like the above can change the landscape on a dime, having a strategy is good, but having the ability to be light on your feet is just as important.
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