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USD/CAD Hits 1 Year Highs, Is 1.40 Next?

Summary:
USD/CAD Hits 1 Year Highs, Is 1.40 Next? MACRO 2018 was a brutal year for the Canadian dollar. The currency hasn’t been this cheap since May 2017. Over the past year, the loonie lost more than 7% of its value against the greenback and 10% of its value versus the Japanese Yen. At 1.3600, USD/CAD is trading much closer to its 5 year high of 1.4690 than its 5 year low of .9930. The currency’s decline boiled down to 2 things – oil and the U.S. dollar. The price of crude fell 25% last year but from its peak in October, it is down a staggering 44%. Western Canada Select, the spot price for Alberta oil is down only 18% but that’s only after a sharp recovery in December as it is off 50% from its peak in May. Aside from the decline in oil, the Canadian dollar was also driven lower by U.S.

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USD/CAD Hits 1 Year Highs, Is 1.40 Next?

MACRO

2018 was a brutal year for the Canadian dollar. The currency hasn’t been this cheap since May 2017. Over the past year, the loonie lost more than 7% of its value against the greenback and 10% of its value versus the Japanese Yen. At 1.3600, USD/CAD is trading much closer to its 5 year high of 1.4690 than its 5 year low of .9930. The currency’s decline boiled down to 2 things – oil and the U.S. dollar. The price of crude fell 25% last year but from its peak in October, it is down a staggering 44%. Western Canada Select, the spot price for Alberta oil is down only 18% but that’s only after a sharp recovery in December as it is off 50% from its peak in May. Aside from the decline in oil, the Canadian dollar was also driven lower by U.S. dollar strength.

But it could have been alot worse. If not for the U.S. Mexico Canada agreement (USMCA), strong labor market gains and decent growth, the Canadian dollar would be much weaker. The USMCA agreement was the most significant development for Canada last year. It eliminated a major uncertainty that could have been very bad for the currency. It still needs to be ratified and while House Democrats could express some concerns, it will pass in 2019. In the coming year we expect early weakness for Canada’s economy followed by late strength. For USD/CAD this means that we could see 1.40 before a move down to 1.30.

In the coming year the same drivers that carried the loonie lower could be the ones that drive it higher – probably not in the beginning of the year but certainly as the year progresses. Oil prices are low but in December OPEC countries agreed to cut production and if prices do not turn higher soon, the threat of further losses will prompt additional reductions. When that happens, the loonie could finally benefit from the falling U.S. dollar. By all counts, the greenback peaked in 2018 and is poised for further losses in 2019. The Canadian dollar was the only currency that failed to benefit at year-end because of oil but as crude prices stabilize, so will the loonie.

MICRO

Starting with the bad news, the first 2 months of the year could be rough for Canada as growth will be dampened by lower oil prices, slowing housing activity and equity market weakness. Despite the USMCA agreement, Canadian steel, aluminum, lumber and solar panel exports are still subject to tariffs which means these sectors will struggle to recover. According to the table below, consumer spending growth stagnated towards year end, consumer price growth slowed to the point where CPI dropped below 2% and manufacturing activity is well off its highs. Data in the front of the year should be softer, giving the bears more reasons to drive CAD lower.

The good news is that the labor market is very strong with more than 94K jobs created in the month of November. This was the single biggest one month job gain since April 2010 when 108K jobs were created. The unemployment rate is at a four decade low and all of this has helped to encourage strong GDP growth. Also population is growing at healthy pace and two major liquefied natural gas projects worth $50 billion Canadian dollars could provide some economic momentum mid year. This should be followed by fiscal stimulus ahead of the October general election where Prime Minister Trudeau is expected to win easily.

USD/CAD Hits 1 Year Highs, Is 1.40 Next?

MONETARY POLICY

Like the Federal Reserve, the Bank of Canada is widely expected to raise interest rates this year and the question is just how quickly. The Fed could lift rates again in the first quarter while the BoC could wait until Q2. What’s interesting about the BoC is how quickly their views changed last year. Right after they raised interest rates in October, they said rates will need to rise to a neutral stance to achieve the inflation target and this was interpreted to mean that there could be a December or January hike. However with crude prices falling 44% from October and December and the TSX index falling 14% during this same period, their outlook changed as the risks to growth shifted from the upside to downside. So in December, they find themselves with less wiggle room and like the Fed they resorted to saying that future moves will be “decidedly data dependent.” This means there are no plans to raise interest rates in the early part of the year, which reinforces our view that USD/CAD is headed higher before it peaks and turns lower.

Kathy Lien
Kathy Lien is an Internationally Published Author and Managing Director of BK Asset Management. Her trading books include the following: 1) For beginners, “The Little Book of Currency Trading (2010, Wiley).” 2) THIRD edition of the highly acclaimed, internationally published “Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings (2015, Wiley).” 3) Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game (2007, Wiley) 4) High Probability Trading Setups for the Currency Market E-Book (2006, Investopedia)

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