02.20.09 cad

Canadian Dollar’s Future Dependent On Relative Growth

Fundamental Outlook for Canadian Dollar: Bearish

- Leading Indicators Index sees its biggest drop on record through January – a bad omen
Consumer inflation eases more than expected, opening the door a little wider to rate cuts
- Interest in Canadian assets tumbles as concerns over growth and financial health are raised

While there are many Canadian dollar crosses; none are as important as USDCAD. It is the most heavily traded of the loonie pairs, it joins two of the worlds largest trade partners and juxtaposes two very different economic paths. With notable event risk and ongoing questions as to the health of the Canadian economy and markets, traders with a fundamental interest in the Canadian dollar will focus on USDCAD.

When putting the two economies’ fundamental dockets next to each other, there are few that would say that the Canadian data will overwhelm the flow from the US for USDCAD’s affections. However, it will all have its influence on the Canadian economy in the end. From the US docket, Canadian traders will monitor the consumer, production and finally GDP figures for guidance. Trade with the US represent nearly 80 percent of total exports which in turn is a major component of the broader economy. With consumer confidence state-side scraping recent record lows and orders for durable goods (offering pull-through demand for machinery and offering an indication of activity going forward) tumbling, it is clear that there will be limited demand for Canadian goods, services and especially resources going forward. The most prominent reading for Canada – perhaps from either calendar – will be the second reading of US 4Q GDP. This may be a revision on a lagging indicator; but it is open to dramatic adjustments – the kind that can redefine growth expectations and the US dollar’s place as a safe haven and fundamental in the recovery from a global recession. Naturally, should confidence in the US falter, the forecast for global activity and the health of its largest trade partner will suffer as well.

Canada’s docket has its own market movers – and prominent ones at that. Come Monday, the on-again-off-again top market moving retail sales report will cross the wires with what is expected to be a massive 2.7 percent contraction. Domestic consumption is vital to the Canadian economy at this point where the absence of foreign demand has to be filled in by local sources to avoid a deeper recession that could easily spiral out of control. There will further be interest in the current account balance for the fourth quarter. This is the broadest measure of trade for the economy – encompassing both physical and capital flows. We know that the physical trade balance has suffered as global production activity suffers with the global recession and in turn squashes demand for Canada’s natural resources. But, will we see capital inflows make up for this deficit as investors look for a safe haven in the comparatively stable economy and markets in Canada.

However, are the Canadian economy and markets as strong as the stubborn Canadian currency would suggest? This is the primary (yet vague) question that loonie traders have been asking and will continue to ask. Benchmarking growth is easy enough, with guidance from local data and basing expectations through the US’s path. For the health of the financial sector, there are still many potential mines that have not gone off. A plunge in economic activity could easily leverage the strain in the credit and capital markets. However, policy makers have already acted in a precautionary capacity. Will it be enough? We shall soon see. - JK