Canadian Dollar Forecast July 2015

Canadian Dollar Outlook July 2015

The U.S. dollar outlook remains strong driven by uncertainty with respect to Greece, a strong US economy in the US, and weakness in the Canadian economy. These factors all help towards a stronger US dollar outlook.

With recent weakness in Canadian GDP data, many are suggesting the Bank of Canada may be looking to cut interest rates again and this is a negative for the Canadian dollar.

In determining the US dollar outlook, Canadian and U.S., economic data and monetary policy remain the main drivers of the Canadian dollar with oil prices continuing to be a secondary but important factor. Recent weakness in oil prices will continue to weigh on the Canadian dollar.

Canadian dollar bears continue to have a favorable outlook and should look to a strengthening U.S. economy and hawkish Fed Monetary Policy in building their case. In looking for continued support, key data in terms of the U.S. continues to be data related to jobs, manufacturing, construction, housing, and consumer spending. On the domestic front, Canadian dollar bears should look to increasingly stable but relatively low oil prices in continuing to limit Canadian dollar upside. Furthermore, interest rate differentials and the increasing likelihood of a rate hike in the fall/winter months by the Fed versus the relatively neutral stance by the Bank of Canada will continue to push the U.S. dollar higher while keeping the Canadian dollar weak. Overall, Canadian dollar bears will need to keep an eye on U.S. economic data and Fed policy, relative to Canadian economic data and Bank of Canada policy.

Canadian dollar bulls will continue to be disappointed looking forward due to relative policy outlook between Canada and the U.S. With the Bank of Canada continuing its neutral stance driven by positive but unsatisfactory economic data, the Canadian dollar stands to suffer from an increasing stance in policy normalization from the Fed. Going forward, low oil prices should continue to stabilize and provide floor support for the Canadian Dollar. However, due to the expectation of the Canadian economy to lag the U.S. economy with GDP growth expected to be less than 2% year over year this year, stabilizing oil prices may not go very far. Furthermore, with wage growth relatively weak and home ownership levels at record highs, consumer sentiment and spending is expected to provide little support to end the year. Other domestic factors contributing to a weak Canadian dollar looking forward include weak business investment, poor energy sector outlook, and poor sales growth. Overall, Canadian dollar bulls must hope for surprisingly positive Canadian economic data relative to the U.S. should the Canadian dollar bull case ever have a chance this year. Rising oil prices would also help.

Summary
The US dollar has been gaining steam recently driven by strong economic fundamentals in the US, weakness in Canadian data, and uncertainty with respect to Greece. Look for USD/CAD to remain rangebound but grind slightly higher as we move closer towards certainty of a US rate hike. A year end target of 1.28 USD/CAD is not unreasonable if the US economy continues to outperform the Canadian economy.

Oil Prices
While oil prices continue to have a high correlation with the Canadian Dollar, it has become more of a secondary factor, taking a back seat to relative economic data and policy between the U.S. and Canada. That being said, oil prices are still significant to the Canadian dollar outlook and have continued to stabilize over the last month although they have fallen very recently.

Canadian Economy and Bank of Canada
With a Q1 GDP contraction of .6%, the expected rebound in the second half of the year will likely result in growth of less that 2% year over year. In addition, consumer sentiment and spending is leaning towards the cautious side in the second half of the year due to poor wage growth and record high home ownership levels. On a more positive tone, the labour market continues to be stable with projections remaining at 10,000 jobs per month driven by increased manufacturing output due to the low Canadian dollar. Furthermore, vehicle sales continue to be a silver lining in an otherwise poor consumer spending environment. Manufacturing and non-energy exports also continue to benefit the Canadian economy due to strengthening U.S. construction, rising auto sales, and a weak Canadian dollar. Unfortunately, Business investment has and will likely remain to be weak due to a weak energy sector and moderate sales growth. As a result businesses are also cautious with regards to capital expenditures despite loose lending conditions and relatively strong balance sheets. Overall, core inflation has increased and sits a little above 2% giving evidence to significant pass-through effects of a weak Canadian dollar to imported goods such as food.

 
Because of all this, the Bank of Canada is expected to maintain a neutral stance for the remainder of the year, however, the Bank of Canada could also look towards another rate cut if data remains weak in Canada. The Bank of Canada will release a monetary policy report on July 15th, 2015 and will likely highlight upside and downside factors with projections pointing to moderate risk with regards to extending output gap closure further. Further upside risk of monetary tightening will also hinge on effects of Fed rate increases.

U.S. Economy and Federal Reserve
The U.S. economy is hinting at a rebound during the spring and second half of the year as projections look strong as the effects of energy sector cutbacks, weather, transportation, and production disruptions begin to fade. Growth, however, still remains moderate at 2.5% year over year for the second quarter. Looking forward, upside in the U.S. economy has been displayed in strong consumer confidence and spending, especially in the auto sector, driven by strong job and wage growth, favourable lending conditions, and a rising stock and real estate market. Furthermore, U.S. housing activity has also increased significantly in recent months but has been offset by cutbacks in the oil & gas sectors and weak exports due to the strong U.S. dollar. Lastly, an expected gradual increase in interest rates will allow for sustained affordability in terms of lending. This will allow continued strengthening of housing activity and labour market activity which will continue to support the U.S. recovery. Overall, core inflation sits at a little below 2% year over year.
Speaking towards the anticipated interest rate hike, the exact date is still hard to determine however the likelihood of it happening in 2015 grows stronger. Leading projections anticipate a hike as early as September as the U.S. economy continues to strengthen. Systemic risk from Greece remains as a potential factor in influencing interest rate decisions.