Is the rally in the Canadian dollar coming to an end?
In an effort to avoid a terribly overused term in financial commentary (the term is also the title of a George Clooney fishing flick), we’ve gone for the literal definition instead.
Over the past few months, several factors combined have helped propel the Canadian dollar (CAD) higher and / or the US dollar (USD) lower, bringing the Canadian dollar to 83 cents. This run made the CAD the best performing currency among the top 11 currencies so far in 2021, up 5.3% (graph 1).
Such a movement over five months has turned some heads, especially when investors see their assets denominated in US fighting against this strong headwind.
Against the USD, it’s clear that 2021 has seen risky currencies like the CAD, Norwegian krone, and Australian dollar perform much better. Meanwhile, safe haven currencies, including the yen and Swiss franc, have lagged behind. The USD is also considered a safe haven currency. With the acceleration of global growth as the pandemic emerges, this is a favorable market for currencies.
CAD tail wind
There are many factors that helped the CAD rise to 83 cents. Everyone would agree that the Bank of Canada and the US Federal Reserve remain dovish on any historic measures, including overnight lending rates and active bond buying activity (quantitative easing). However, it was the relative moves or the degree of complacency that favored the CAD. The Bank of Canada has started to scale back its quantitative easing as the Fed continues. It would be hard to call the Bank of Canada hawkish, but in this mad world of money printing, the new hawkish is less accommodating.
Perhaps the biggest tailwind for the CAD has been rising commodity prices. Whether we like it or not, our currency is viewed in global currency markets as a base currency. And the rise in commodity prices has many assumptions or questions whether we are at the start of a new commodity super cycle. (graph 2)
If you think we are in a commodities super cycle, the CAD has further upside potential. This is not the opinion of our investment committee. While many products
prices have appreciated to levels not seen since the last commodity super cycle, we believe this is a temporary phenomenon for several reasons. Most evidently, the change in consumer behavior during social distancing from the pandemic has resulted in increased spending on durable goods. Durable goods require more goods than non-durable goods and services. This change in behavior has caused an increase in demand for commodities while logistics and capacity remain limited due to the pandemic. We believe that this increase in demand will fade with the reopening and the reduction of supply chain bottlenecks.
To have a new commodity super cycle, the world needs consistently high aggregate demand growth over many years. Similar to those experienced during the rapid industrialization of Japan or the urbanization of China (graph 3). We are not seeing any of these secular shifts in demand develop and believe this surge in commodity prices will fade away. At the same time, so will the strength of the Canadian dollar.
Where to go from here?
There are many reasons to be both bullish for the CAD and bearish for the CAD, in terms of the USD. Short-term bulls in the CAD may cite the resumption of global growth, the extent of the recovery in the US economy, with commodity prices and relative returns being quite tight. Longer term, well, there are often rumors that the United States is gradually losing its reserve currency status as world trade becomes more balanced.
For Canadian investors, the USD / CAD impact is often a zero-sum game. In CAD terms, the USD rises in risk-free market environments and falls in times of risk. Obviously, this makes exposure to the US dollar a good diversification tool for Canadians. Now at 83 cents and benefiting from a competition of factors, we think the CAD has incorporated a lot (or almost) of good news, making a lower move for the CAD as a higher probability event (aka USD plus Student).
After that run and at 83 cents, it seems like a good time to add some exposure to the US dollar.
Source: Charts are sourced from Bloomberg LP and Richardson Wealth, unless otherwise noted.
All opinions expressed here are solely those of the authors and do not represent the views or opinions of any other person or entity..