Canadian Dollar to Underperform as Focus Turns to Yields

The currency markets’ response to Friday’s better-than-expected US Retail Sales report supports the emergence of a tectonic shift in the underlying forces guiding price action in the weeks and months ahead. The inverse relationship between the US Dollar and equities that had firmly held since last year’s credit crunch dissipated, with both stock prices and the greenback pushing higher. Further still, most major currencies’ (excluding the British Pound) relative performance against USD following the Retail Sales report fell squarely in line with the priced-in yield outlook for the next 12 months. Those currencies looking ahead to significant monetary tightening suffered relatively smaller losses against the greenback, while those with little or no rate hikes on the horizon sank sharply lower. This symmetry did not escape the Canadian Dollar, which performed third-worst against USD and is only ahead of the Yen and the Swiss Franc with regard to priced-in yield gains for the coming year.

A similar outcome emerged last week as a wildly better-than-expected US jobs report. On balance, both instances suggest that currency markets are beginning to see the first signs of a decoupling from the risk vs. safety dichotomy that had characterized them over the past two years and moving back towards being driven by the most traditional of fundamental catalysts: interest rates. Indeed, the Federal Reserve typically waits for labor markets to show durable signs of improvement before raising interest rates after a recession, and both the sales and jobs reports encouraged perceptions that this may now happen sooner than previously thought.

The implications of a move to yield-driven trading is that the market will begin to realize that the Canadian Dollar is neither the Australian nor the New Zealand currency despite having traded as such since 2008: it represents an economy whose fortunes are linked to demand from the comparatively sluggish US rather than the antipodeans’ buoyant Chinese patron, whose low interest rates are comparatively unattractive (and expected to lag those in the States), and whose top export commodity – crude oil – hit a two month low last week and is poised to extend losses. On balance, this means a readjustment is in order, pushing CAD lower against its commodity bloc counterparts and the US Dollar.