Canadian Dollar Outlook February 2015

Canadian Dollar Outlook February 2015

Bank of Canada and Oil Prices
The Canadian dollar continues to remain very volatile. The Bank of Canada shocked markets with a recent rate cut and many expect the Bank of Canada to cut rates even further. The key driver for the Bank of Canada at the moment is oil prices, which have been falling, and this is expected to impact Canada’s economy and job prospects.

The Bank of Canada indicated they are not afraid to be pre-emptive and cut rates even if the market is not expecting it. Their focus is to protect the Canadian economy. The falling Canadian dollar is likely a positive for the Canadian economy it makes exports from Canada more attractive to the US.

With oil and natural resources making up a meaningful size of the Canadian export economy (20%-30%), the Bank of Canada is assuming $60 oil for the time being. If oil prices remain under $60 for a long period of time, the Bank of Canada may cut interest rates again and this is negative for the Canadian dollar.

Falling oil prices hurts the oil and has sector, the nearby economic activity that supports the oil and has sector such as capital spending and infrastructure. While Canadians will save on falling oil prices at the gas station, the overall impact on the Canadian economy is a net negative just because of how much of a factor oil plays in Canada’s economic growth.

Many now expect a 50% chance the Bank of Canada cuts interest rates again this year in the next 6 months, the chance of a further rate cut after that would significantly impact the Canadian dollar. A likely scenario for this would be oil at $35/bbl and flat GDP growth.

A lower Canadian dollar should help the manufacturing and export sector in Canada and acts as stimulus to the Canadian economy. In essence, the Bank of Canada is likely quite content to see a falling Canadian dollar. With global central banks increasing stimulus and cutting rates, the Bank of Canada is fitting in nicely.

US Dollar and Federal Reserve
The Fed continues to be leaning towards a rate hike driven by a strengthening economy and strong job growth in the US. Stronger economic data out of the US will continue to push the US dollar higher as the Fed moves closer towards an interest rate hike.

The US dollar remains the flavor of the month and continues to have broad based strength. US economic fundamentals along with the US dollar safe haven status have flow of funds moving towards the US. While falling oil prices are negative for Canada, they are typically positive for the US economy as consumers will have more money to spend due to cheaper oil prices at the gas station.

Inflation in the US is not a threat and this is the primary reason why the US Fed has not been raising interest rates already. Labor market strength is in the US will push US wage growth higher and the Fed will likely be at the beginning of the wage growth curve when they start to hike interest rates.

Greece and the Eurozone
Greece has a new left leaning government and is looking to renegotiate a deal with its debt partners in the Eurozone. The current deal expires on February 28th, 2015. The people of Greece do not want austerity. However, they were the ones that benefited from the massive spending that built the debt. Moreover, other countries don’t want to be responsible for debt they did not incur and the people of those countries surely don’t want to be giving funds to the people of Greece for their overspending.

There are a number of outcomes that remain possible with Greece’s negotiation with its Eurozone partners. They could exit the eurozone (unlikely) or ease the terms of austerity (likely). Greece leaving the eurozone would set panic in the markets as it just creates a lot of uncertainty for markets. Uncertainty is usually a positive for the US dollar as it is a safe haven currency.

The Eurozone is back to stimulus mode trying to boost their economy and inflation. The US economy remains the shining light of the developed world.

Currency War
The US dollar has had broad based strength and has been rising against almost every currency. The strong economy, jobs, and safe haven status has drive the US dollar higher. Moreover, global central banks have been cutting rates and adding stimulus, which is weakening their currency relatively speaking. Overall, global central banks prefer a weak currency to boost their local economies, essentially creating a currency war with a flight to the bottom.

Summary
With inflation not a threat in Canada, oil prices low, and the Bank of Canada watching oil prices closely, the Canadian dollar is facing a lot of pressure in the short term.

The Canadian dollar bears are watching for oil prices to remain low, the fallout to trickle through the Canadian job market, to the broader economy, and force the Bank of Canada to cut interest rates. Canadian dollar bears are also hoping the US economy remains strong and forces the Fed to hike interest rates sooner rather than later.

Canadian dollar bulls are hoping for oil supply side cuts to help increase prices close to the Bank of Canada’s $60 assumption. Manufacturing and exports should benefit from a falling Canadian dollar and help offset GDP declines due to the oil and gas sector. The strengthening US economy should trickle down benefit to the Canadian economy. The Bank of Canada will feel comfortable not watching oil prices so closely and indicate rate cuts are off the table.

Overall, the trend is the friend for the US dollar. The US dollar has a lot of momentum and the Canadian dollar is facing many headwinds. In the end, it’s all about the divergent Canadian and US economies.

Look for the USD/CAD to reach 1.30 if oil prices continue to fall. 2015 is the year for the US dollar.