Forex Investment and Currency Trading

FX Bottom-Line: CAD remains a currency linked to the global economic cycle. With the a global recession as the base case scenario, a key fundamental backdrop for Canada’s terms of trade and CAD is fast deteriorating. Canada’s much improved economic fundamentals might prevent an uncontrolled descent, but cannot prevent the inevitable, which is a weaker CAD.

The recent rally in USD/CAD has reflected a clear realization that the global economic outlook is rather rapidly deteriorating.  CAD, and Canada’s terms of trade (the ratio of export to import prices) are closely tied to the overall global economic cycle. In particular, the strength in CAD in recent years
was in large part due to a lengthy global expansion. Between 2003 and 2007, global growth averaged 4.9% y/y, the strongest period of expansion in 30 years that helped spark a sustained surge in Canada’s terms of trade.

Economic Outlook (WEO) warned that the world economy is “entering a major downturn in the face of the most dangerous shock in mature financial markets since the 1930s.” The 2008 global GDP forecast was left at 3.9%%, but the 2009 outlook was slashed from 3.7% to 3.0%, on the cusp of outright recession.. In the April WEO, the chance of a global recession was put at 25%. By October such an outcome has pretty well become the base case and the commentary, If anything, was even more bearish than the forecast. The deterioration in the global economic outlook, with risks still heavily tilted to the downside, particularly in the US, remain highly relevant to Canada, where exports still account for 37% of Canadian real GDP, 76.6% of Canadian exports head to the US, and as Canadian real exports continue to track US domestic demand quite closely. With the expectation of quarterly contractions in US domestic demand through 2009 Q2, net trade will remain a large drag on Canadian GDP, and employment contributing to USD/CAD bullishness.

Even so, CAD has been serving as a relative safe haven reflecting Canada’s sound banking system (as confirmed by the World Economic Forum’s 2008-09 Global Competitiveness Report), credible fiscal policy, limited exposure to fickle foreign investors, and current account surplus. These factors have helped CAD perform remarkably well amid recent chaos, as other commodity or cyclically sensitive assets were pounded. As the financial crisis remains the key risk to global growth, Canada’s much improved fundamentals will help limit the USD/CAD topside in coming months.

Still consistent with the global economic cycle, USD/CAD is expected to rally through 2009. A key
determinant of the CAD outlook toward late 2009 and 2010 will be whether the global policymakers manage to ensure systemic stability and thus whether the global economy is set to experience a potentially painful, though largely cyclical downturn, or a lengthier structural downturn reflecting withdrawal from a liquidity induced hallucination. The former scenario remains the most likely at present and holds hope for Canada to expand trade with China, particularly in energy, and for CAD to emerge as a true petrocurrency in 2010 as global growth returns to trend. The latter is not longer a remote, scenario and would feature a more sustained downturn, a further decline in commodity prices, and persistent upside risks to USD/CAD.