Canadian Dollar: A Little Less About Oil, a Little More about Rates

Of the majors, only sterling was
weaker than the Canadian dollar in Q3.
  Sterling’s drop was a function of its decision to leave the EU
and ease monetary policy.   The Canadian dollar fell 1.6% compared
with sterling’s 2.6% fall.  The other dollar-bloc currencies were among
the strongest of the majors, with the Australian dollar rising almost 3% and
the New Zealand dollar gaining a little more than 2%.


Many investors continue to see the Canadian dollar as a petrol currency.
 
However, in recent months, this relationship has loosened.  Consider that
at the end of the Q2, the 60-day rolling correlation between the percentage
change in the US dollar against the Canadian dollar and the percentage change
in the price of light sweet oil was a little more than -0.70, which is the most
extreme it has been since oil turned in mid-2014.

It became less extreme over the course of
the quarter.
 
Yesterday, it reached -0.45, the weakest
correlation since March 2015.  In the nine months here in 2016, the US
dollar has moved against the Canadian dollar in the same direction that oil
moved in five.

Another driver, which in our work is often present, may be at work:
interest rates. 
Here are two charts that illustrate our point. 
The first Great
Graphic
, composed on Bloomberg, overlays the US two-year premium over
Canada (white line) and the US dollar against the Canadian dollar (yellow
line).  The purpose here is just to illustrate the co-movement.

Correlations cannot be eyeballed
We looked at the rolling 60-day correlation between the percent change in the
US dollar against the Canadian dollar and the percent change in the two-year
spread.  This is depicted in the
second Bloomberg chart.  At the end of last month, the correlation rose to
nearly 0.55.  It is not far from that now.  To appreciate the
significance, one has to go back to the late-1990s to see a higher
correlation.

Over the past three months, the Canadian two-year yield has
risen by nine bp and the similar US yield
has risen by 25 bp. 
  Canada is in no position to match a Fed
hike, even if they do not cut rates again.  

Although it will be overshadowed by
the US jobs report on Friday, Canada also reports its September employment data
at the same time.
  While the monthly numbers jump around the six and
12-month averages, have been fairly steady this year.  The six-month average
has moved this year between 3k and 11k.  The 12-month average has been
between 6k and 12k.

Yesterday, Canada reported a smaller than expected August trade deficit. 
The C$1.94 deficit was the smallest since January,
and the July shortfall was revised to
smaller.  Exports rose for their third consecutive month, but are still
off 2.5% year-over-year.  Canada’s exports to the US are off a little more than 5% year-over-year and fell 1.6% in August
alone.  

Canada’s exports to the UK surged 25% in August, despite the depreciation
of sterling.
  Statscan reported that shipments to the UK accounted for
the bulk of the increase in
exports.  Canada’s exports of unwrought gold to the UK rose dramatically,
but probably is not recurring business.     Energy exports hit a
two-year low in May and rose 5.3% in
August. 

Like several other countries, Canada continues to wrestle with risk
emanating from the property market.
  There seems to be a rough
consensus among policymakers that interest rate policy may be too blunt of an instrument.  Instead, macro-prudential
policies are preferable.  Earlier this week, Canadian Finance Minister
Morneau announced new measures that may begin going into effect as soon as
October 17. 

These measures include a stress test for home buyers and new income
eligibility requirement for mortgage insurance. 
Morneau warned that
see an 8% decline home sales, which is around the decline seen between April
and August this year.  Some private sector estimates suggest a larger
hit.

The US-Canada lumber dispute will also come to a head by the middle of
October. 
The previous arrangement that put a tariff on Canada’s
softwood lumber imports to compensate for Canadian producers access to cheap lumber from government lands
expired a year ago.  Over the past year, Canada has been able to export
lumber to the US duty-free, and it
has.  Canadian exports of lumber to the US have risen by nearly a
quarter. 

If there is no agreement on October
12, US companies can initiate new trade cases
. US producers want to limit
Canadian imports to a fixed market share.  Some Canadian producers want to
choose between a tariff model and an volume
cap, like the last agreement. 

The US dollar fell from almost CAD1.47 at the end of January to CAD1.2460
in early-May.
  Since then it has bounced along its trough, never
getting above the CAD1.33 level, which corresponds with a 38.2% retracement of
the fall.    Based on our expectation for a December rate Fed hike,
and two hikes next year, over the medium-term we expect the US dollar to work
its way above CAD1.3575 (50% retracement) and more toward CAD1.3840 (61.8%
retracement and congestion area from last February. 

Disclaimer 

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