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CAD is poised to take back some of the lost ground, most notably against some of the currencies that strongly outperformed since June 4, such as USD, NZD and GBP.

NZD/CAD and GBP/CAD have already begun to retrace some of the June gains, but there is more scope for CAD to rally.

CAD had weakened since the BoC’s June 4 rate decision, which noted that should “the unprecedentedly rapid rise in the Canadian dollar” in May prove “persistent” it could thwart an expected recovery. A weak May jobs report on June 5 added to CAD heaviness. But, the most pronounced period of CAD weakness was from June 11 onward as oil prices peaked and BoC Governor Carney’s spoke (on June 12) reiterating and unquestionably reinforcing the risk posed by a strong CAD. In relatively short order USD/CAD rallied from 1.10 to near 1.16. Meantime, other G10 currencies remained relatively steady, within a range of +/- 1.5%.

A measure of CAD weakness was sensible, particularly later in June. The crude oil price curve has moved lower since June 11, although it still lies above that of May 29, when USD/CAD was near 1.10. Thus, some retreat in CAD mid-month onwards was reasonable. And, in fact, NOK was the second worst performing G10 currency from June 11 to June 30 as oil prices retreated. But the 1.7% rally in USD/NOK pales next to CAD weakness. That implies a lot of FX action was attributable to the BoC communication strategy. The SNB, which has talked tough and repeatedly intervened (confirmed or not) in EUR/CHF and USD/CHF since mid-March can only dream of having such an inexpensive market impact. The BoC might soon be reminded that there is no such thing as a free lunch, and the fragility of backing up currency moves with only a wall of words.

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Though CAD is poised for near-term outperformance, there are hurdles to extended CAD strength. Four event risks loom, including this Friday’s June employment, and May trade reports. On Monday July 13, the BoC releases its Business Outlook Survey (BOS) and the relatively new Senior Loan Officer Survey.
The BOS was conducted around the June rate decision date, or near the recent USD/CAD low. These reports will provide critical information on the enormous slack in the Canadian economy (employment and the BOS), the strain on exports and trade, credit market conditions and the business sectors confidence in the BoC’s inflation target range. The inflation target’s credibility is the key factor keeping the BoC from exploring quantitative easing. In the prior BOS, a record share of firms anticipated inflation below 1%, the bottom of the BoC target range. The BoC won’t be able to dismiss more widespread expectations of very low inflation.

These concerns effectively boil down to one statistic: CAD. CAD strength makes a recovery more challenging, opening up more slack, weighing on exporter and manufacturer confidence, keeping the job market under pressure and adding to disinflationary risks. CAD weakness would ease these concerns and allow Carney to have a much more enjoyable summer. Even so, CAD weakness has gone too far, too fast and CAD is poised to outperform in the near term, particularly against USD, NZD and GBP. The BoC will be carefully minding the gap.