Double Blow To Canada Causes Loonie To Lose Strength

Political Uncertainty

The major piece of uncertainty in the markets right now is the political fate of Canadian Prime Minister Paul Martin, which may very well be decided by tomorrow, May 19.  Paul Martin, is frantically searching for political support as the upcoming federal budget vote draws near. Martin, and his ten-month-old administration have been in hot water ever since a scandal involving the previous government taking kickbacks for campaign advertising in Quebec surfaced. The liberal government was apparently attempting to promote federalism by sponsoring sporting and cultural events in the province; however, party members were found to have taken a good portion of rake-offs from the scheme. Although this occurred when the former Prime Minister, Jean Chr�tien was in office, Martin was serving as his finance minister. Martin remains firm in his rhetoric that he took no part in any illegal activity; nevertheless, he has apologized repeatedly for the Liberal Party’s actions.

Martin and his administration are feeling the heat from their opponents, the conservative Tories who are taking full advantage of the Liberal’s slip up. With the road to power wide open, the opposition party has called for a vote of no confidence and stepped up their political advertising campaign. However, Martin is proving to be a formidable opponent even with the scandal ranging. Martin has expressed that he will regard the vote on the federal budget as a vote of no confidence, stating that if it does not pass, he will step down. The latest polls remain divided with the Liberals holding a minor lead.  Two independent polls put the Liberals at 33% versus 30-31% for the Conservatives.   After an initial plummeting of public opinion right after the scandal broke, the Liberals have managed to regain some territory with the Canadian population. While some surveys still have the Tories almost eleven percentage points higher than the liberals, others show them in a dead heat. It seems that many people are upset with the current administration but do not want another election so soon. The Tories seem to be taking this sentiment into account, hinting that they will stop trying to oust Martin if his party can get the budget passed in the federal budget meeting on May 19th.

Oil Prices Receding

Being the ninth largest producer of crude oil in the world, Canada’s currency has a strong positive correlation with oil prices.  In fact, over the past year, the weekly correlation has been close to 70%.  This means that if oil prices rally, the Canadian dollar also has a high likelihood of rallying, but unfortunately the pitfall of this relationship is that the opposite scenario is true as well.  When oil prices fall, the Canadian dollar will collapse as well.  Therefore with oil prices 15% off its April highs, the Canadian dollar has sold off 4% in tandem.  At this point, unless oil prices embark on its strong uptrend once again, don’t count on the black grease to lend the loonie any support. 


Yet all hope is not lost.  China is Canada’s second largest trade partner next to the United States.  Between 2003 and 2004, exports to China increased 38.6%.  With the world’s most populated country growing by 9.5% in the first quarter of 2005.  There are no signs that the Asian giant is slowing.  This is even truer in regards to China’s demand for commodities.   China is just beginning to embark on its path of modernization.  Even though they have a population of 1.3 billion people, which is 4 times more than the US, their consumption of core commodities is still relatively smaller than its more industrialized peers.  As the country continues to grow and increase productivity, their demand for commodities are expected to increase as well.  This long-term source of demand will provide persistent support to the industries of heavy commodity exporters such as Canada.  For the USDCAD, this should keep any post election USDCAD gains limited. 

Expect a Rate Hike Over The Next Few Months

Also aiding the Canadian in the months to come is to prospect of more rate hikes.  The last monetary policy meeting held by the Bank of Canada was on April 12, 2005.  At the time the BoC decided to leave interest rates unchanged at 2.50%, which is the sixth month that the central bank has stood pat on interest rates. According to the Bank of Canada, companies are coping well with CAD strength and that another rate hike may be right around the corner. Canada expects domestic demand to lead economic growth, but have left policy accommodative in hopes of spurring growth in face of weaker external demand. Higher commodity prices have benefited resource-rich Canada, but have hurt Canadian exports to countries such as the US, which accounts for two thirds of total exports for Canada. The BoC still believes that monetary stimulus reduction "will be required over time," solidifying the need for another rate hike as early as July.