When the Canadian dollar almost touched 72.46 cents (U.S.) back in early May, we turned very bullish on the currency. Let's briefly revisit that period:
- The mantra of the day was that the problems at Home Capital were not company-specific but a canary in the coal mine for the entire Canadian banking system.
- There were concerns that the bubbly housing markets in Vancouver and the Greater Toronto Area were going to topple over and create a made-in-Canada recession.
- The speculators in the futures and options pits had started to take out huge short positions on the Canadian dollar.
- The prevailing view at the time was that the Bank of Canada was going to be forced to cut rates.
- Oil prices were sliding then and there was a consensus forecast building at the time that WTI was heading back to the early 2016 lows, and would take the loonie along for the ride.
- Canada was going to get hit hard by U.S. trade barriers and the rewriting of the North American free-trade agreement.
- The Fed was going to hike rates and drive a further negative wedge between Canadian and U.S. front-end bond yields.
A lot of bad news was priced in at that point. If any or all of these factors did not come to fruition, then the case for a short-covering rally would be very strong, indeed. At that near-72.46-cent level in May, the moving averages were closer to 75.19 cents, as a measure of how oversold the currency had become.
But the dollar touched 80.65 cents back on July 26, and at that point it hit the mirror image of the maximum weakness at 72.46 cents back on May 4. Now, those speculative shorts have swung to net longs. Oil is range-bound but still has not broken down – and who doesn't know about all the efficiencies around shale and lack of compliance at the Organization of Petroleum Exporting Countries? About the global supply glut? These things aren't universally known?
Canada not only did not enter a recession, but has emerged as the strongest economy in the Group of Seven and growth now is running about a percentage point better than it is in the United States.
As for trade issues, nobody seems to care much about the NAFTA issue any longer. And let's face it – if U.S. President Donald Trump's bite was as bad his bark, China would have been labelled a currency manipulator by now, as was so often pledged during the election campaign.
So none of the worries that undermined the loonie took hold – not one – and so, like a rubber band, the currency overshot to 80.65 cents and is now on its way to correcting back toward 76.92 cents, which will likely serve as a nice re-entry point for investors as the loonie makes a run for 81 cents to 83 cents when all is said and done. That will then be full mean reversion and a neutral setting for the dollar.
No doubt Canada has its share of competitiveness issues, such as taxation and ineffectual energy strategies. At the same time, Canada is winning the battle on high-skilled immigration inflow, and this makes up for a lot of the self-imposed constraints on growth. There is some concern over Friday's trade data – the deficit jumping to $3.6-billion (Canadian) in June from $1.4-billion in May, and of course, exports diving 4.3 per cent opened a lot of eyes (steepest slide since February, 2016). But much of this reflected energy and gold exports and even with the setback, export volumes rose at a healthy 11-per-cent annual rate in the second quarter. This pushed the odds of a September Bank of Canada rate hike down to 30 per cent, but the possibility of an October hike is still 65 per cent as per the overnight index swap market. Exports of industrial machinery actually rose 1.5 per cent, which shows that manufacturing competitiveness is still decent even with the loonie's ascent. And imports of electronic and electrical equipment jumped 2.1 per cent, which is good news in terms of the outlook for capital expenditures. And of course, these data were for June – we already know the jobs numbers were pretty good, too: full-time positions up 35,000, manufacturing payrolls up 14,000 and Ontario posted a sizeable 26,000 run-up.
One last point needs to be made. We focus primarily on the Canada-U.S. relationship, but the loonie's strength has been much more broadly based. On a non-U.S.-dollar trade-weighted basis, the loonie has actually rallied 4.6 per cent from the nearby lows posted during the spring. So this is not merely the dollar getting caught in the widespread decline in the greenback. And it is not just a commodity story, either, because the loonie is up nearly 3 per cent from the nearby low against the Aussie dollar; and similarly up 4.5 per cent from the nearby low against the New Zealand dollar. What makes the Canadian dollar bull run more durable is that unlike most of the other central banks – the Fed, Bank of England and Reserve Bank of Australia have turned a bit more dovish – the Bank of Canada most recently hiked rates, raised its growth forecast and, just as important, lifted its confidence in that more bullish forecast and has yet to try and talk down the currency.
David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.