USD/CAD to Trend Higher into the Summer
By Jonathan Clark
The CAD shows a strong positive historical correlation with Canadian equities, so that recent developments should be positive for the currency. The broad Stoxx Europe 600 Index is at its highest level since June of 2008, while the US S&P 500 is within a few percent of its peak from October of 2007. The S&P/Toronto 60 has yet to break out of its trading range of the past 7 weeks despite upward pressure on stocks around the globe. We expect global equities to peak by mid-April or sooner. The CAD began a downtrend around the middle of January, even before Canadian stocks stalled in their uptrend. This weakness in the currency can’t be explained by crude oil prices as they didn’t start their decline until the middle of February, while natural gas prices are higher on the year.
The main cause of the decline in the Canadian dollar is falling interest rates in Canada versus those in the US and particularly further out the yield curve. US Treasury 10-year Notes pay 10 basis points more than the equivalent Bond in Canada, while US 30-year Bonds have an interest rate advantage of 61 basis points over Canada. The Bank of Canada kept its overnight interest rate unchanged at 1% due to the struggling economy, but the central bank has yet to abandon the stance that the next move in rates will be a hike. Recent data showed Canada's economy only expanded by 0.2% in the fourth quarter, the slowest annual pace since the end of the recession. BoC Governor Mark Carney considers the current soft patch in the Canadian economy to be temporary and that exports will pick up, but we are not so certain. Typically, US growth stimulates Canadian growth, but the US will struggle with austerity. In addition, US production of energy has increased 18% in the past three years. Canada’s energy exports, which are almost entirely to the US, are down 14% from their peak and Canada is running a relatively high current account deficit-to-GDP ratio of nearly 4%. A combination of falling interest rates and weak trade will drag down the CAD.
USD/CAD is overbought according to our medium-term rate-of-change measure and this argues that it will pull back before resuming its uptrend. We expect it to form a peak by the start of next week and hold below the 1.0385 to 1.0405 at this time. The cycles call for a low late next week or the week of March 18. Our target for this downmove is the 1.0135 area and, if seen, this should be a good place to buy for the next leg of the uptrend. Dollar/Canada should then break above the resistance area and this will confirm it is headed higher into May or June. Our further objective for the uptrend is the 1.0600 area.
