The Bank of Canada seems to have brought its rate reduction cycle to a halt in July of 2015. The BOC noted in its press release the offsetting effect of lower transitory consumer prices while the loonie depreciated. Still the BOC determined that the rate of inflation was still well below the target 2.0% level. It’s reasonable to conclude that although a commodity exporting economy, Canadian consumer prices were being kept in check by the very same pass down of lower commodity prices.
Another major concern at the time was the apparent slowing of the US economy, Canada’s most significant trade partner as well as the seismic shift beginning to unwind in China’s economy, a major global importer of industrial and strategic commodities[i]. “...Global growth faltered in early 2015, principally in the United States and China... ... indicators suggest a rebound in the U.S. economy in the second half of this year... ...China is slowing amid an ongoing process of rebalancing to a more sustainable growth path. This has pulled down prices of certain commodities that are important to Canada’s exports...” Lastly, the BOC took into account the global accommodative monetary policies, thus justified a 25 basis point reduction in its overnight rate target.
The US Fed appeared to be signaling a Fed Funds target increase in September, in spite of the recent mediocre employment report. San Francisco Fed President, Mr. John Williams was quoted while speaking at a Chamber of Commerce meeting, stating that[ii] “...September would be a very plausible time to start liftoff...” However, it was not to be.
It’s interesting to note at this point the comparison with a 12 month chart of USD/CAD exchange and a chart of the corresponding front month contracts. The loonie saw its best vs the US dollar in mid-May of 2015 at CAD $1.19667. Within the same time frame, light sweet crude traded at about USD $61.00 per barrel. From the 12 month high, the loonie began a steady decline with a clear correlation with the price of oil. In fact, the chart demonstrates that when the futures contracts leveled off between late August through Early December, so too did USD/CAD, trading just above loonie resistance at CAD $1.2933 and testing loonie support of CAD $1.3508. When the commodity decline resumed in December, loonie convincingly broke support a trended sharply lower to the 12 month low of CAD $1.4562 on 20 January, 2016; a 21% decline from the May 2015 high.
It should be noted that at the loonie vs US dollar low, oil future contracts had touched USD $27.73 per barrel. Within a few weeks, the contracts would reach their 12 month low at just above USD $26.00 per barrel.
Immediately following the low, the loonie began a steady and steep recovery vs the US Dollar and did so slightly ahead of the rally in oil which has persisted to the present day. As oil regained, so too did the Loonie. However, the Loonie jump start on the oil rally may have had another contributing factor: the US Fed apparent change in its policy bias from tightening, back towards accommodative. Keep in mind that the Fed was expected to increase Fed funds in gradual increments, a cycle which had begun last December. In fact the BOC had made note of the expected rate hike cycle at its January policy meeting[iii]: “...The U.S. Federal Reserve has begun to gradually withdraw its exceptional monetary stimulus...” However, at the same time the US Fed seemed to increasingly take into account the weakness in the global economy as noted in the January statement[iv]: “...The Committee is closely monitoring global economic and financial developments and is assessing their implications ...” . The FOMC further signaled its concern at the March meeting[v]: “...global economic and financial developments continue to pose risks...”
The BOC seemed to have anticipated the Fed shift as noted in the 9 March 2016 policy statement[vi], one week ahead of the Fed’s March statement: “...in light of shifting expectations for monetary policy in Canada and the United States, the Canadian dollar has appreciated from its recent lows...” Indeed, from the 20 January low of CAD $1.4562 the loonie appreciated to CAD $1.2628; a gain of 13.28%.
At this point it’s worth noting that 73% of Canadian exports are destined for US markets and 4.7% for China’s markets. Canada exports well over 95% of its crude to the USA, and a much lesser amount to China. Further, automobiles comprise 10% of Canada’s total exports, and 95% of that is destined for US markets. Hence, two major components of Canada’s export economy are dependent on a ‘non-strengthening’ US dollar and interest rates which over the past few years have led to record automobile sales in the US.
There’s one last factor which may inhibit the Fed from progressing with its planned increases at least until September, but possibly until December. Traditionally, as an fully independent entity of the US Government, the US Fed does not act too near national election. Both leading political parties nominate their presidential candidates at conventions in July, and the general election is in November. Unless economic data demonstrates a clear danger to the US economy on way or the other, the most ‘appropriate’ time to act would be in June or September. If the data does not warrant an increase, the Fed will wait until December.
So although petroleum exports are a major component of Canada’s economy, so too is a major manufacturing sector. With no further BOC rate reductions expected and no further US Fed rate increases at least until June or September, the USD/CAD will likely be a function of petroleum prices; i.e., the loonie is likely to respond to petroleum, measure for measure.
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[i] BOC Press Release 15-7-2015
[ii] Reuters 15-7-2015
[iii] BOC Press Release 20-1-2016
[iv] US Fed Press Release 27-1-2016
[v] US Fed Press Release 16-1-2016
[vi] BOC Press Release 9-3-2016