Canadian Dollar – Consolidation or Direction Change?

As the geese return to Canada to sit on fairways everywhere, the CAD has also been showing some positive signs.  To put things into perspective, the CAD dropped from about 0.95 to a low of 0.78 in March, but over the past week has rocketed higher to just over 0.82.  This has been a big move of four cents in the past week.  So this begs the question: is the Loonie set to regain its lost ground, or is this the random noise of the markets?

 

Currencies tend to move on the ebb and flow of data.  The rise in the CAD during the first half of 2014 was aided by strong energy prices, better Canadian economic data and some softness in the U.S. data, pushing out further the ever elusive Fed rate hike.  The decline in the CAD in the 2nd half of 2014 was on the energy price collapse and accelerated when the Bank of Canada unexpectedly cut rates in January.  The recent recovery has been from some strong Canadian data, reduced likelihood of another rate cut and some delays in the expected U.S. rate hike (again).  It’s almost like a pendulum swinging back and forth.

 

Longer term we still prefer the U.S. dollar. Better economic growth, deleveraged consumer rates likely to rise later this year, the list goes on. However, the biggest driver has to be the longest looking driver – our currency does well when there is a bullish commodity cycle. Unfortunately, there was a strong commodity cycle from 2003-2008 that was partially salvaged by QE and U.S. dollar debasement in 2010-2013. But, we are now on the dark side of the commodity cycle and that is a benefit to the U.S. dollar and a detriment to CAD.

 

There is another reason to embrace the U.S. dollar – it may be a better diversifier than even bonds (take that modern portfolio theory). If you are primarily a Canadian equity investor, your biggest fears are likely centered on a few key events (or they should be). A slowdown in the Global economy weighs heavily on our equity market. But, it also weighs heavily on our currency, which benefits U.S. dollar denominated investments.  The U.S. dollar is viewed as the safe haven, so having some of these in case of global economic weakness or tensions acts as a natural diversifier (even in equity form).  Then there is the Canadian housing market - we don't believe it is set to pop, but our real estate market is a risk and it weighs on the Banks.  If trouble does develop in our real estate market, it will hurt the banks and hurt the Canadian dollar.  Again, some U.S. dollar exposure would act as a nice buffer or diversifier.