Forex Investment and Currency Trading

For nearly 6 months now USD/CAD has straddled an exceptionally narrow seven big figure range between 0.97 and 1.04, oscillating above and below parity. This behavior of a currency caught between a rock and a hard-place is well justified and likely to persist in the months ahead, although we anticipate a slight bias toward CAD strength within a 0.95 – 1.05 range in Q2/Q3. Protecting USD/CAD’s downside, notably below 0.95, are considerations of valuation. PPP is important for USD/CAD than most currencies, as Canadians have the capacity to vote with their feet and shop south of the border, as they did when USD/CAD briefly fell below 0.95. Also constraining the downside is the perceptions that the best of the commodity cycle has passed. Buoyant commodity prices have acted as a significant offset to the negative US demand shock, and exports in value terms have so far not been as weak as expected. However real import growth has been far stronger than other G7 countries, leaving real net exports a major drag on growth. The flip side of strong imports has however been stunning domestic demand that is seen continuing to outstrip equivalent US numbers by close to 4%! The main differentiation with the US, has been residential investment. There are early signs from Canadian housing starts and building permits that this is flattening out, but house prices are still in positive terrain, consistent with earlier assumptions that the stresses in the Canadian banking system could be contained to select arenas without severe repercussions for the real economy.

While domestic demand has not made aggressive easing imperative, the BoC has been true to its multi year warnings of downside risks to the US economy, by acting preemptively, utilizing the flexibility afforded by a much improved inflation outlook. The market is pricing in a BoC broadly matching Fed actions. If the Fed cuts more than the market expects, the BoC is not expected to fully match such easing, placing downward pressure on USD/CAD. Again softer commodity prices will act as a constraint under this scenario, not least because a longer period of finance sector constrained growth and a commodities cap will constrain FDI flows.

Though there is a perception that the CAD is unusually strong when USD/CAD is near parity, the real CAD TWI is not especially strong at less than 4% above its 10yr average, something that can be fully justified by the cumulative positive terms of trade shock in recent years. In Q2, the biggest risks to the upside of the range near 1.05 are less about Canada, than if the market jumps the gun, and briefly over enthuses about a US V-shaped recovery, which would then provide the best sell USD/CAD opportunity.