Back in April, we wrote that it was time to sell dollars and buy the loonie. For a trade, the call was spot on as USD/CAD shot up literally the next day. Since then, the currency pair has been trading in a range from the 1.20 to 1.28 area. I’m not a technical analyst but let me lay out some reasons, again, why I think the loonie may still be a very good call at this point.
First of all, it’s been a LONG time since this pair has traded at these levels. Historically, this is a really weak trading range for the Canadian dollar. I’m talking more than five years! If you look at the charts, the currency typically doesn’t stay at these levels for a long period of time.
Second, I think we’ve seen the worst in the collapse of the price of crude oil. The amount of the crude downdraft was a shock to a resource-driven economy like Canada’s. The loonie traded down in lock-step. It seems to me that oil will trade around the $60 level or even go higher since the rig count in the United States has plummeted. Shale oil is not going away and the damage to the old energy production model is forever changed. However, I think the worst of the price shock is behind us. As crude rebounds, Canada’s fortunes will rise with it. This will include increased economic growth and a reason for the Bank of Canada to raise interest rates, which will of course impact the trading level of the currency.
There is another wild card which has yet to be seriously played regarding the price of oil. The Middle East is ablaze and could easily morph into a conflict which could impact the supply of crude emanating from the oil rich region. A fight with an aggressive Iranian navy, ISIS conquering more oil wells, or a war in Saudi Arabia with the Islamic State could very easily happen. This would cause a spike in oil prices that would not easily go away. Again, this would be more upwards pressure on the loonie.
Canada’s economic growth unfortunately also depends on America’s economic situation. We are definitely seeing some firming in the United State’s economy. The last Congressional election enshrined a conservative majority which will provide support for business friendly policies and enhanced trade. The market will see this and discount increased economic activity in the future. As the 2016 elections approach, this effect will be enhanced as I believe the Republicans will take control of the executive branch. This will cause the markets to rally substantially. Increased economic growth south of the border will produce more demand for Canadian goods and services.
At some point, the Bank of Canada will have to start making noise about raising rates. Recently they have been non-committal but this does not mean they are not considering hiking the short term cost of borrowing. The BOC doesn’t want to be accused of being behind-the-curve in the face of a possible increase in inflation. The Federal Reserve in the United States is already being criticized for this scenario.
In short, if you have dollar assets, it may be a good idea to take some profits off the table and move into undervalued currencies, such as the Canadian dollar.
Todd Wood is a former emerging market debt trader with 18 years of Wall Street and international experience. He is also an author of historical fiction thriller novels. His first of several books, Currency, deals with the consequences of overwhelming sovereign debt. He is a contributor to Fox Business, Newsmax TV, and others. LToddWood.com