Santa has already made his list, and checked it twice. His decision is made, and that has the Loonie on edge. In just a few days, it could receive a lump of coal and extend its recent losses to the May 2017 low of 72.60 cents. (compared to the US dollar) On the other hand, if it’s Christmas wish is fulfilled the currency could climb to 77.00 cents.
It has been a tough year for the Canadian dollar. It started 2018 on a positive note, adding to gains achieved in the previous December. The Bank of Canada helped by raising the overnight rate by 0.25% to 1.25% on January 17. Prices reached 81.60 cents compared to the US dollar (USDCAD 1.2255) at the end of the month. Barring a miracle, that level will be the highest level for the currency this year.
A lot of the Canadian dollar weakness in 2018 was due to broad-based US dollar demand. At the end of 2017, some analysts predicted the US dollar would weaken as central banks in the major centers started to raise rates which would narrow the US dollars’ interest rate advantage. That sentiment had the greenback on the defensive in January. Then a funny thing happened on the way to the dollar’s funeral.
Global and domestic investors fell back in love with the greenback and the outlook for US rates. President Trump’s stimulus packages (with the President, not so much) which included massive infrastructure spending and lower tax rates lit a fire on Wall Street. The major indices posted “record closes” on a regular basis, up until the end of August. Everybody wanted US assets, and the dollar rallied. Trump triggered trade “wars” with Canada, Mexico and China adding fuel to US dollar demand. Expectations for a somewhat hawkish bias from the European Central Bank (ECB) proved unwarranted. ECB President Mario Draghi stuck to a dovish script which encouraged additional dollar buying.
President Trump personally plucked the feathers from the Loonie. He fulfilled a campaign promise and sparked a renegotiation of the North America Free Trade Agreement (Nafta). Then he stacked the deck in his favour by imposing tariffs on imports of Canadian steel and aluminum while threatening to slap 25% tariffs on imports of cars. The Canadian dollar suffered, and even after a new United States Mexico Agreement (USMCA) on trade arose from the ashes of Nafta, the Loonie couldn’t get much air. That’s due, in part because Canada did not negotiate the removal of the steel and aluminum tariffs.
The Canadian dollar’s failure to launch after the new USMCA deal coincided with elevated China/US trade tensions and tit-for-tat tariffs between the two nations. Those talks restarted a week ago, but according to Chief US Trade Representative Robert Lighthizer, China has a “hard deadline” of March 1 to come to terms. G-10 major currencies including the Canadian dollar will be at the mercy of US dollar ebbs and flows which in turn will be driven by headlines on the as the deadline approaches.
The trade woes kicked the Loonie to the ground, but oil traders stomped it. A 35.7% drop in the price of West Texas Intermediate (WTI) since September inflamed Canadian dollar selling. The impact from the price drop was worsened by “made in Canada” distribution issues. Alberta producers were pumping furiously even as pipeline constraints led to storage constraints which led to a bigger discount for Western Canada Select. (WCS)
The Bank of Canada took notice. (BoC) The precipitous plunge in oil prices forced them to adopt a dovish stance at its December monetary policy meeting, and it caught FX traders off guard. The BoC warned that low oil prices would have a “meaningful impact on the Canadian economy” and made a note of the widening WCS discount to WTI. The Bank also expressed concern about the US/China trade tensions. The December message was a far cry from the October statement. At that time, they were full of optimism from the USMCA deal suggesting that it would have a positive impact on business confidence and investment. At that time analysts were projecting three rate hikes in 2019. Today, even two is questionable.
The Federal Open Market Committee meeting is December 19, and there is a 75% chance that they will raise the fed funds range to the 2.25-2.50% level. After that, the CME Fedwatch tool suggests the odds for another increase in 2019 are less than 50%. Many economists expect at least two more increases. The new Summary of Economic projections and the tone of Chair Powell’s press conference should set the stage for year-end and early January markets. A more hawkish than expected Fed would knock the Canadian dollar for another loop.
The Loonie may have ticked off more boxes on the “naughty” side of the equation in 2018, and that points to a large lump of anthracite in certain stockings.