By Michael O’Neill
The Canadian dollar is currently facing numerous financial challenges, encompassing a mix of foreign and domestic economic data, shifts in monetary policy, fiscal concerns, and geopolitical factors. The currency has been experiencing sudden and unpredictable value fluctuations, characterized by erratic trajectories. However, despite this volatility, these movements have remained within a 600-point range over the past 5 months.
This pattern is expected to persist for the next five months as global risk sentiment dances with concerns regarding deteriorating relations between the US and China, the risk of intensifying conflict between Russia and Ukraine, and monetary policy mismanagement by key central banks, including the Bank of Canada (BoC).
The BoC will decide whether to raise or maintain rates at the current level on June 7. After consistently raising rates at each meeting for over a year, the BoC pressed the pause button on March 8, 2023, and kept rates unchanged at 4.5% during the April and May meetings. However, policymakers may resume their actions next week due to economic data not aligning with the Bank’s models. The May 16 inflation report showed improvement, with inflation being well below the 8.1% year-on-year peak observed last June. However, the details suggested that the downward trend in inflation was stalling around 4.0%, posing a challenge for the BoC as their inflation target is 2.0%.
Moreover, the previous rate hikes have not produced the desired effects in cooling the economy. First-quarter GDP data surpassed expectations, and Statistics Canada’s advance estimate for April GDP is 0.2%.
The Reserve Bank of Australia (RBA) faced a similar situation, pausing its rate hikes in April while noting that the pause did not imply an end to rate increases. BoC Governor Tiff Macklem made similar comments regarding domestic rates, and the recent string of stronger than expected economic data suggests that the BoC will raise rates by 25 basis points next week.
A rate hike could potentially benefit the Canadian dollar, as observed with the Australian dollar’s over 1.4% rally following the RBA’s surprise hike. However, these gains are not likely to be sustained, as was the case with the Australian dollar. The Canadian dollar’s behavior is expected to be similar, given the dominant influence of the United States on currency markets.
The Canadian dollar sank and soared when global markets fretted about Russian President Putin’s nuclear threats, China’s aggressive posturing around Taiwan, Opec oil production cuts, the US banking crisis, the FOMC’s interest rate outlook, and the debt-ceiling suspension debate.
The debt ceiling debate should be resolved by June 5 or D-Day will take on a whole whole different meaning. And, even if the default is avoided, the fall-out will roil global markets for months afterwards.
JPMorgan economists estimate issuance will be $1.1 trillion in seven months. They said if it happens, it will pressure liquidity, raise rates charged on near-term loans and make funding expensive for corporations and could reopen the US regional banking system wounds from March and April. It may be a doomsday scenario but the risks are worth noting.
Opec and Russia may be having a lovers’ quarrel. The cartel is unhappy with the slide in oil prices and would like to cut production further to limit the downside. Russia pumps about 9.5 million barrels/day and wants production unchanged.
Opec could cut production despite Russia’s objections and count on G-7 sanctions to prevent Russia from exploiting the move. Higher oil prices are usually favorable for the Canadian dollar, but the transition from fossil fuels to alternative energy sources means that the impact of higher prices on the Canadian dollar is less than in previous years.
China and US relations are strained. They are at the point where Chinese Defense Minister Li Shangfu has refused to meet US Defense Secretary Lloyd Austin. China may have a point as Mr Shangfu has been sanctioned by the Americans for acquiring Russian weapons.
Oil market and debt ceiling concerns are a circus sideshow as the FOMC is in the center ring. The Fed and the market have been at odds over US interest rates direction. Fed Chair Jerome Powell insisted that US rates would rise higher and remain elevated until 2023.
Traders and analysts disagreed and at about a month ago, expected nearly 100 bps of cuts by December 31. They had an epiphany after a recent rash of robust economic data. Where they once expected the Fed to leave rates unchanged on June 14, they now expect a 25 bp hike. That change in view occurred after Mr. Powell hinted that the Fed may hit the rate hike pause button. The ever-shifting rate outlook goes a long way in explaining market volatility.
USDCAD has traded erratically in a 1.3250-1.3860 range since the beginning of the year. The factors that created the range are still in play. It is the Loonie Vortex.