Published: March 20th, 2024
One of Canada's largest banks is predicting a bout of Canadian Dollar weakness over the next few months as the Ottawa central bankers face up to the fact that interest rate policy is too restrictive.
An analysis by National Bank of Canada (NBC) describes recent positive performance by the Loonie as ‘lukewarm’, especially when contrasted with other commodity currencies like the New Zealand and Australian Dollars.
NBC analysts call CAD ‘the weakest amongst the strong’, blaming low performance against other commodity currencies on underwhelming economic figures.
In a note to investors the bank parses recent Canadian economic data and pulls out areas of weakness undermining Q4 GDP growth statistics, among them confirmation that Canadian domestic demand had fallen for the first time in 12 months. NBC says the tepid fundamentals of the Canada's economy can be blamed on Bank of Canada (BoC) interest rate policy, which at five per cent is draining vitality and hindering growth.
‘The downside of the BoC's restrictive monetary policy is easier to see when you look at private domestic demand, which shrank for two consecutive quarters and has now dipped four times in six quarters.’
‘The bank has lost the justification for maintaining such a restrictive monetary approach.’
NBC also believes that Canada's most recent labor market print is overly optimistic, as the headline 41K expansion seen in February was inflated by public sector job postings. The bank notes that private-sector employment has sat more or less unchanged since June of last year.
According to NBC, all of this indicates that the Bank of Canada will be compelled to cut interest rates. On a year-to-year comparison, inflation has already fallen back to Ottawa's 1-3 per cent target range, currently 2.9 per cent.
In April of 2023, the Loonie received a shot in the arm as oil prices rose by more than 8 per cent in the wake of a surprise production cut pledge by the OPEC+ group.
Markets were blindsided by an announcement from the crude cartel that saw members agree to slash nearly 1.7 million barrels of oil per day from May 2023 through to December. The Saudis agreed to the most extensive cuts, scaling back production by 500,000 barrels per day.
An analysis by Bloomberg said the move would give support to petro-currencies like CAD. While the cuts would tighten crude supply, the world economy would see a fresh inflationary jolt as a side effect.
Central banks were expected to act, meaning more rate increases than markets had priced-in before the OPEC+ bombshell. At the time (early April), USD/CAD was close to dipping below a bullish trend line after reaching some key support levels.
Alongside the Saudis, Russia extended a previously announced cut of 500,000 barrels per day through to year-end. Several other Gulf states also joined the group policy and announced their own cuts.
A production cut of nearly 1.7 million barrels of oil per day was significant, Bloomberg said, and would meet the cartel's aim of keeping crude prices supported.
The USD/CAD rate was also impacted by improving risk appetite across financial markets. The US Federal Reserve had been signaling that rate increases might be paused, putting the Greenback on the back foot.
The core PCE Price Index, which is the Fed's benchmark inflation gauge, came in weaker than expected on Friday 31st March. The OPEC+ announcement followed the next day and will likely compel Fed policymakers to re-think rate decisions.
Meanwhile this week could be a busy one for CAD bulls, with Canadian employment reports, private payrolls and ISM services PMI all due before week's end.
As recently as December 2022, analysts were saying the return of declining crude oil prices would pull the Canadian Dollar down in 2023.
Analysts at Bank of Montreal (BMO) said a (then) recent dip in oil prices looked like a long-term trend, and is contributing to the Loonie's recent decline. They do say, however, that an oil price recovery is expected next year. That would give CAD some support.
‘The unexpected decline in oil prices over the past seven days has trickled through to forex markets in the ways we would expect,’ wrote BMO in a recent currency briefing. For the Canadian Dollar, that's manifesting as underperformance linked to oil market dynamics. ‘The surprising shift in crude prices is hammering commodity currencies like CAD.’
The Loonie had been the biggest loser amongst the major commodity currencies over a 30-day period, though it wasn't alone. The Norwegian Krone, Europe's top petrocurrency, was also on the back foot.
BMO said all these moves confirmed the oil linkage. ‘What we are seeing is a broad rally for oil importing currencies while oil exporter currencies suffer.’
BMO noted that the Pound to Loonie (GBP/CAD) exchange rate had risen for five weeks in a row, extending an appreciating trend that first emerged in September 2022.
Earlier in July 2022, analysts at Montreal-based Desjardins Bank were saying the Canadian Dollar was headed for steady declines.
In a mid-year currency market analysis, economists at the bank's FX Strategy Unit said the global economic outlook would be challenging over the coming months, a backdrop which would work against the Commodity-sensitive Loonie. Rising interest rates from the Bank of Canada (BoC) were also expected to add headwinds by pressurizing Canadian households already laden with credit card debt.
‘Global recession worries are already impacting the Canadian dollar, which isn't normally seen as a safe haven during times of upheaval. Markets are still disrupted, and risk-appetite remains weak across the board, though there have been occasional spikes of optimism.’
Investors were also expecting Ottawa to lift interest rates by nearly 200 basis points over the next six months as policy makers looked to cap rising inflation and try to work in parallel with the US Federal Reserve.
‘Markets are looking for interest rate rises in Canada to be at the high end, though not high enough to nudge CAD's value upward. Hiking interest rates could also aggravate Canada's high levels of household debt and even cause a significant correction in the residential housing market.’