By Michael O’Neill
Canadians have a lot to be thankful for in 2017.They can be thankful for the competitive resurgence of Canadian NHL teams. They can be thankful that hurricanes and earthquakes are extremely rare, north of the 49th parallel. They can be thankful that only the police and bad guys carry guns. And, they can be thankful that the Canadian dollar did not collapse like it was poised to do, on May 5.
A mere five months ago, the Loonie looked like it would be suffering the same fate as Thanksgiving turkey. Decapitated, stuffed and baked at 325 degrees.
The negatives were piling up like Canada’s federal debt. The Trump administration reopened the soft-wood lumber can of worms by slapping a 20% countervailing duty on Canadian imports. Rumours were flying that President Trump would terminate the NAFTA agreement, the domestic economy was flat, and oil prices were sinking. Some forecasters predicted a 66 cent Canadian dollar against the US dollar.
The doom and gloom evaporated in the heat of the summer. Deputy Governor Carolyn Wilkins announced a hawkish shift in the Bank of Canada’s monetary policy in June. That was followed up by an interest rate hike in July. The Canadian interest rate increases coincided with a robust oil rally that took West Texas Intermediate from $42.07/barrel to $52.75 in September. Domestic economic growth surpassed forecasts.
The Bank of Canada (BoC) caught markets by surprise when they raised rates for the second time in September. Economists and strategists grabbed their erasers and changed their Canadian dollar forecasts from 66 cents to 87 cents believing the hawkish BoC would hike a third time in October.
Thanksgiving has arrived and with it a more subdued outlook for the currency. BoC Governor Poloz provided some interest rate clarity last week. The Governor crushed expectations for an October rate increase. He said that the BoC was “data-dependent” and cautious about the inflation outlook.
Many economists believe that Canadian economic growth has already peaked as many temporary drivers have faded, including spending benefits from the Child Tax Credit and the cooling off of the housing market.
Those beliefs and the Mr Poloz’s comments have seen the 87 cent year-end forecast change to 77 cents.
Canadian dollar risks seem to be balanced in the final quarter of the year. The prospect of further BoC rate increases in 2018 (or even December 2017) will temper bearish sentiment arising from the US rate outlook. The oil market has recovered from various price shocks. West Texas Intermediate prices have stabilized in the $50.00/barrel area. Canadian economic growth is expected to finish the year with a respectable 3.1% growth rate.l
There are plenty of negative risks. The 219% countervailing duties slapped on to Bombardier by the US suggests that the NAFTA negotiations aren’t going well. The Canadian economy is expected to slow to 2.5% in Q3 and 2.2% in Q4. If those forecasts are worse than expected, the Canadian dollar will sink.
President Trump’s tax cuts, if they ever get approved, will underpin the US dollar and act as a drag on Canadian dollar gains.
The European Central Bank appears reluctant to turn off the “easy money” taps. Spain and it’s Catalonia region is a flashpoint which could disrupt the fourth largest economy in the eurozone. North Korea has faded from the headlines, but risk aversion risks are just a missile launch away. All of the above will underpin the US dollar.
There are negative risks to the US dollar as well. Chief among them is succession talk at the Federal Reserve. Federal Reserve Chair Janet Yellen’s term expires at the end of January. President Trump famously said that he would replace Janet Yellen when he was campaigning for the job. He hasn’t said much on the subject since then.
The Fed succession talk ramped higher this week. It was also a slow news period ahead of the usually important US employment report. A story circulated earlier in the week that the President’s advisers had given him a short-list of five candidates for Chair of the Federal Reserve.
The Wall Street Journal reported Fed governor Jerome Powell was interviewed by Mr Trump on September 29. Another report said that Mr Powell was Treasury Secretary Mnuchin’s choice for the job. There wasn’t much reaction to the Wall Street Journal story but this week’s rehash led to some US dollar selling. Mr Powell is considered to be a dove.
Kevin Warsh is a former Fed governor and a current lecturer at the Stamford Graduate School of Business. On October 3, CNBC said that he was the front-runner to replace Janet Yellen. He is thought to be a hawk who favours less regulation in the financial sector.
Gary Cohn is on the list. He is a former President of Golman Sachs Group Inc and a fan of financial deregulation.
John Taylor is another candidate and thought to be hawk. He is also the creator of the “Taylor Rule.” which the Fed uses to help set interest rates.
Last, but not least is the incumbent, Janet Yellen. She is the most qualified candidate for the job considering it is already hers. She is a known quantity and seems to have done a decent job. However, she is well past retirement age and may not want to be reappointed.
The dialogue around naming the next Chair of the Federal Reserve may expose the US dollar to volatility with the direction determined by whoever is the leading candidate.
Canadian’s may be giving thanks that the Canadian dollar didn’t collapse in May, but Q4 has just started. Our bird is still at risk of being over-cooked.