The Canadian Dollar…What’s next?
What is New on the Macro Level? by Hubert Marleau of Palos Management, Montreal
Put simply, Interest Rates Differentials (IRD) between Canada and the U.S. are basically flat. Their outlook for economic growth is similar and North American inflation is destined to converge toward the 2% target. Thus, the path of monetary policy between Canada and the U.S. should be identical.
Based on these observations, the exchange value of the Canadian dollar should revert back to our calculated Canadian Purchasing Power Parity (PPPR) of 78.5 US cents. Unfortunately, the calculation is not independent of risks like the price of oil, NAFTA negotiations and the unhealthy financial conditions of Canadian households. Should the price of oil fall below its marginal cost of production, which is around $55 a barrel, the NAFTA negotiations conclude in a negative manner, or indebted households stop spending, the Loonie could become subject to a negative reversal of fortunes.
Barring these low probability outcomes, the Bank of Canada will likely be the major driver behind the future performance of the Loonie. In this connection, the odds of an October or December rate hike are low. Mr. Poloz is likely to ease up and embrace a more cautious approach. A few days ago, he said that “there is no predetermined path for interest rates from here”. It confirms the belief that from here on out, the tightening will be gradual and slow and, in turn, follow the decisions of the Federal Reserve Bank. Recent economic data in Canada, listed below, supports the above view.
• The pace of economic activity is slowing down towards 2.0%;
• The annual rate of inflation is accelerating towards the target goal of 2.0%.
• The policy rates are more than halfway to where the neutral rate is;
• The amount of spare industrial capacity has considerably reduced and so has overall economic slack;
• Full employment has either been reached or attained; • Bloomberg Nanos Canadian Confidence Index, Canadian consumer confidence is waning.
The ongoing increase in productivity is dampening the inflationary effect of rising wage rates on consumer prices. “This is happening as the world’s major central banks are slowly taking their feet off the monetary policy accelerator, with steps to wind down their final post-crisis stimulus programs or to begin the process of raising rates.
All told, the major central banks are setting policy for more than 90% of the world balance of reserve currencies and are actively raising rates or taking concrete steps to end easing programs, mostly reflecting improving economic conditions” reports the WSJ. If you have any questions about the weekly commentary, the securities that we follow, or investment ideas, please contact us at [email protected]
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