Riding High: TSX Triumph and the Loonie's Balancing Act
Saturday, October 12, 2024 (Week 41)
The Canadian dollar (CAD) has demonstrated remarkable resilience in recent weeks, deftly navigating a dynamic environment of record TSX highs and fluctuating oil prices. This updated analysis examines the key market themes shaping the CAD's performance, provides an in-depth look at Canada's economic fundamentals, and offers a revised investment thesis for the upcoming periods.
The dominant theme impacting the CAD over the past week has been the TSX's remarkable performance amidst global market volatility. Driven by strong gains in commodity producers and robust financials, the TSX reached an all-time high of 24,302 on October 10th, boosting the CAD. However, the loonie's strength was tested by external factors, notably hotter-than-expected US inflation data released on the same day.Despite Canada’s better-than-expected Q2 GDP growth of 2.1% (annualised), the CAD faced headwinds from a broadly stronger USD (Source: Statistics Canada).
The interplay between the TSX's record-breaking run and the BoC's cautious easing cycle has been the most influential theme for the CAD over the past month. The TSX's relentless climb to new highs, fueled by optimism surrounding potential Fed rate cuts and strong commodity-linked stocks, provided substantial support for the loonie. On September 13th, the TSX closed at an all-time high of 23,569. However, the BoC's decision to cut its policy rate by 25bps to 4.25% on September 4th, along with Governor Macklem’s cautious comments regarding future easing, introduced uncertainty. The rise in Canada's unemployment rate to a two-year high of 6.6% in August further complicated the narrative.
Investment Thesis
Upcoming Week (October 12th - 18th): Neutral. The CAD is expected to trade within a range, influenced by a confluence of domestic and international factors. Key data releases, such as the September inflation report (due October 15th) and August retail sales (due October 25th) will be critical. Market sentiment and US economic data will also play a significant role. Geopolitical developments could further exacerbate volatility.
Upcoming Month (October 12th - November 30th): Cautiously Bullish. The CAD's medium-term outlook leans cautiously bullish, depending on sustained TSX strength and positive economic data. Eased inflation in August, with the CPI at 2%, may allow for a more dovish BoC stance, potentially supporting the loonie (Source: Statistics Canada). External factors, including the potential for a US recession or further escalation of geopolitical risks, remain key downside risks.
Canada's Economic Landscape
Second Quarter GDP Growth
Canada's economy exhibited resilience in Q2 2024, with GDP growing at an annualised rate of 2.1%, surpassing the 1.6% forecast. This strength, fuelled by government spending and business investment, suggests a healthy economic backdrop. However, monthly GDP stalled in August, following a revised 0.2% growth in July. The Bank of Canada anticipates 1.5% annualised growth for Q3. While positive Q2 results might support the CAD, recent stagnation warrants monitoring.
Easing Inflationary Pressures
Inflation in Canada cooled to the BoC's 2% target in August, a three-year low (Source: Statistics Canada). This easing trend, primarily driven by falling gasoline prices, supports the argument for more rate cuts. Core inflation also reached a 40-month low of 1.5% in August. While the disinflationary trend is broadly positive for the CAD, rising food prices, with a 1.2% uptick in September, warrant continued observation.
Labour Market Uncertainty
Canada’s labour market presents mixed signals. The unemployment rate declined to 6.5% in September, defying expectations. However, employment growth has been volatile, with a 46,700 increase in September contrasting sharply with the loss of 2.8k jobs in July. Wage growth also moderated, reaching 4.6% in September. This uncertainty complicates the BoC’s policy outlook.
Improved Sentiment
Consumer and business sentiment in Canada has recently brightened. The Ivey PMI surged to 53.1 in September, indicating expansion (Source: Ivey Business School). Consumer confidence also rose to a six-month high in August. This improved sentiment could translate to stronger consumer spending, potentially supporting the loonie.
Upcoming Key Economic Releases:
Inflation Rate YoY (SEP): Tuesday, October 15th
Housing Starts (SEP): Wednesday, October 16th
BoC Interest Rate Decision: Wednesday, October 23rd
New Housing Price Index MoM (SEP): Thursday, October 24th
Retail Sales MoM (AUG): Friday, October 25th
Bank of Canada: Charting the Monetary Policy Course
BoC Policy
Cautious Dovishness: The BoC's monetary policy stance can best be described as cautiously dovish. The central bank implemented its third consecutive 25 bps rate cut in September, lowering the policy rate to 4.25%. While the initial rate cuts suggested a decisive shift towards easing, Governor Macklem's recent remarks signal a potential moderation in the pace of future reductions. The BoC now appears data-dependent, emphasising the importance of upcoming inflation and retail sales data. On September 6th, traders priced in a nearly 40% probability of a 50 bps rate cut in the future. The minutes from the September meeting highlighted policymakers' concerns about overtightening, given the slowing labour market and potential undershooting of inflation targets. The Summary of Deliberations, to be released following the October 23rd meeting, will offer further insights. This data-dependent approach creates uncertainty around the CAD's near-term direction.
Intermarket Dynamics: Bonds, Equities, and Commodities
Bond Market Signals: Canada's 10-year bond yield sits near 3%, down from the four-week high of 3.20% seen on September 2nd (Source: Trading Economics). This reflects expectations of more BoC easing, though uncertainty lingers around the pace of future cuts. The bond market will be particularly sensitive to forthcoming inflation figures. Subdued inflation could push yields lower, exerting downward pressure on the CAD.
TSX Performance: The S&P/TSX Composite Index continues to exhibit exceptional strength, hitting a new record of 24,302 on October 10th (Source: Bloomberg). This rally, underpinned by gains in commodity producers, financials, and technology, reflects optimism about the Canadian economy. The TSX's performance is closely tied to both global risk appetite and commodity price fluctuations, making it an important barometer for CAD strength.
Commodity Market Fluctuations: Oil, a critical driver of the CAD given Canada’s significant oil exports, has seen price fluctuations. WTI crude has traded between $67 and $77 per barrel, influenced by geopolitical factors, OPEC+ decisions, and demand concerns (Source: Trading Economics). The recent intensification of geopolitical risks adds another layer of complexity to the oil market's outlook and its potential impact on the loonie.
Geopolitical Influences: Navigating Risks and Uncertainties
Political Stability: Canada's political landscape remains stable, with the current government focusing on economic recovery and social initiatives. The upcoming parliamentary session is expected to centre on implementing the 2024 budget's key provisions, notably affordable housing and clean energy projects. Currently, no major political events are anticipated that could pose substantial immediate risks to the CAD.
Geopolitical Tensions and Oil: The escalating tensions in the Middle East represent a significant geopolitical risk for Canada. As a major oil exporter, Canada is particularly vulnerable to disruptions in global energy markets. Further escalation in the Middle East could lead to increased volatility in oil prices, potentially creating both upside and downside risks for the CAD.
Sovereign Strength: Canada maintains a low sovereign risk profile. This is due to strong institutions, political stability, and a healthy fiscal position. Rating agencies have consistently reaffirmed Canada’s AAA credit rating. This reinforces confidence in the CAD’s stability and attractiveness to risk-averse investors.
Currency Valuation: Assessing the Loonie’s Fair Value
The CAD appears to be trading near its fair value against the USD based on economic indicators, purchasing power parity, and interest rate differentials. However, this valuation is subject to change, influenced by future data and policy decisions. Sustained TSX strength and further BoC easing could potentially boost the loonie.
Loonie's Outlook and Key Takeaways
The CAD's trajectory remains closely linked to the performance of the TSX, the BoC's policy path, and global market sentiment. The upcoming week suggests a neutral outlook as markets await crucial Canadian data. The monthly outlook remains cautiously bullish, based on the TSX's robust performance, easing inflation, and assuming no further escalation of geopolitical risks. Canada's economy has demonstrated resilience, yet vulnerabilities persist. These vulnerabilities include potential spill over effects from a possible US recession, oil market uncertainties, and the impact of global economic weakness. Forex traders must remain vigilant, closely observing economic indicators, BoC announcements, and shifts in global risk appetite to effectively navigate the evolving landscape.