By Michael O’Neill
When Charles Dickens wrote the headline in 1859, he was referring to the French Revolution. It is also applicable for describing the outlook for the Canadian dollar today.
The Canadian dollar is the best performing major G-10 currency against the US dollar as of May 12, 2021. It started the year at 78.54 cents to the US and touched 83.00 cents immediately following the release of far higher than expected US April inflation data.
How high can it go?
Ten years ago, the value of the Canadian dollar exceeded the US dollar. On April 21, 2011, 95.23 Canadian cents bought 1 US dollar. It could happen again, especially if analysts forecasting a commodity super-cycle are correct.
Commodity prices are having a great 2021. The S&P Goldman Sachs Index (S&P GSCI) is widely considered a benchmark for commodities investments. It has risen over 28%, year to date and nearly 80% from May 12, 2020. Iron ore, copper and lumber are at all-time highs, which has served to elevate agricultural commodities.
Oil prices are a major driver of Canadian dollar sentiment. West Texas Intermediate (WTI), the North American benchmark price, jumped 40% in just 5 ½ months. Forecasters are predicting $75.00/barrel due to pent-up demand as global economies reopen.
The International Energy Agency (IEA) is forecasting “significantly stronger oil demand beyond the second quarter.” In September 2013, WTI was trading at $110.00/barrel. At that time, the Canadian dollar was 97.56 cents to 1 US dollar (USDCAD 1.0250). If a commodity super-cycle lifts crude above $100/barrel, the Canadian dollar will go along for the ride.
The Canadian dollar rallied even as many provinces imposed fresh coronavirus lockdowns and restrictions at the end of March. Most are still in effect today. Canada was “Johnny-come-lately” to the COVID-19 vaccine sweepstakes, but investors didn’t care. They seem to believe that if the virus didn’t kill you, the money you couldn’t spend would burn a hole in your pocket. The Bank of Canada agrees. They boosted their 2021 growth forecast to 6.5% from 4.3% previously.
The Bank of Canada may also be the first G-10 central bank to raise interest rates, and that news gave the Canadian dollar a big boost. The BoC said that their improved outlook meant they would need to hike interest rates in the second half of 2022. In contrast, Fed Chair Jerome Powell and his colleagues are adamant that the US economy requires ample accommodative monetary policy. They say the Fed is a long way from achieving its dual mandate and will leave US rates unchanged until 2023.
In summary, the Canadian dollar soars as COVID-19 vaccines allow the domestic economy to reopen, unleashing a tsunami of pent-up consumer demand, forcing a modest hike in interest rates. That scenario suggests the Canadian dollar will extend gains to 87.50 cents to 1 US dollar (1.1428).
But there won’t be any glory to the rebound story if the gains are transitory.
Transitory is not the term to describe the Mayor of Toronto riding a bus. It is merely the latest popular adjective in central bank vernacular.
Officials think it makes them sound more intelligent than if they just said “temporary.”
Canadian dollar gains may prove temporary.
Traders ignored last week’s report from the Canadian Parliamentary Budget Office. The PBO noted that the governments projected budget deficit is understated by about $5.6 billion. The budget overstates the impact of stimulus spending. The PBO also notes that the government’s decision to stabilize the federal debt ratio at a higher level means any substantial new spending would require higher revenues or spending cuts.
Oil price gains may run into headwinds. The IEA prediction of a return to pre-pandemic supply-demand levels may be too optimistic, especially if US producers find WTI at $65.00/barrel attractive. Iran’s crude production is expected to return to 3.9 million barrels per day if the US eases sanctions, which could happen by the end of May.
Inflation reared its ugly head in the US. The Consumer Price Index (CPI) jumped to 4.2% y/y from 2.6% in March. That raised eyebrows again, at the Fed. Vice-Chair Richard Clarida said he was “surprised” at the inflation reading and described Friday’s nonfarm payrolls report as “disappointing.” He repeated the Fed mantra that price increases are transitory. Treasury yields jumped to 1.693% from 1.61% following the CPI release. Will Mr Clarida be surprised or disappointed if yields break above 1.75%? Either reaction could lead to US interest rates rising sooner than expected.
This week’s Canadian dollar slide halted right on the 83.00 cent to 1 US dollar level, the equivalent of 1.2048. It is also important from a long term Fibonacci retracement perspective as it represents the 50% retracement of the 2011-2020 range. If it holds, it suggests 1.2050-1.2650 consolidation.
Dickens wrote A Tale of Two Cities in uncertain times. Global geopolitical tensions, coronavirus variants and renewed inflation risks will determine if these are the best of times or worst of times for the Canadian dollar.