The Loonie's Balancing Act: TSX Triumphs Amidst Global Uncertainty
Thursday, October 17, 2024 (Week 42)
The Canadian dollar (CAD) has been navigating a complex landscape this past week (October 6-16), characterised by the interplay of robust domestic equity performance and global economic anxieties. The dominant theme influencing the CAD has been the record-breaking performance of the S&P/TSX Composite Index. This strength stems from strong performances in commodity producers and financial stocks. However, a stronger USD, fuelled by hotter-than-expected US inflation data, has presented headwinds for the CAD. Adding another layer of complexity, concerns linger about slowing inflation in Canada, which dropped to 1.6% in September (Statistics Canada). This raises the possibility of further BoC rate cuts, potentially exerting downward pressure on the CAD.
Over the past month (September 1-October 16), the CAD's performance has been largely shaped by the TSX's record run and speculation surrounding the BoC’s monetary policy. The TSX's surge to new highs, has generated optimism about the Canadian economy and boosted the loonie. However, the BoC’s 25 bps rate cut to 4.25% on September 4th introduced uncertainty about the central bank's future policy direction (Bank of Canada). Further complicating the narrative, Canada's unemployment rate climbed to a two-year high of 6.6% in August (Statistics Canada). This cautious outlook, along with global market volatility and oil price fluctuations, has contributed to the CAD trading within a relatively tight range. Despite Canada’s stronger-than-anticipated Q2 GDP growth of 2.1% (annualised), the CAD has been sensitive to a broadly stronger USD, driven by expectations for a less dovish Federal Reserve (Statistics Canada).
Investment Thesis
Upcoming Week (October 16-25): Neutral. The CAD is expected to remain range-bound this week. Influential factors include domestic data releases like August retail sales (October 25th), reactions to US economic data, and the potential for increased volatility stemming from geopolitical developments.
Upcoming Month (October 16 - November 30): Cautiously Bullish. The CAD's medium-term outlook is cautiously bullish, contingent on a combination of factors. Continued TSX strength, fueled by strong commodity prices, could provide ongoing support. While a more dovish BoC stance is generally expected, the impact on the CAD will depend on the context of any policy decisions. If easing inflation, as suggested by August's 2% CPI figure (Statistics Canada), allows the BoC to cut rates without jeopardising the CAD's attractiveness, it could strengthen the loonie. This scenario hinges on the market interpreting such a move as a sign of economic stability and proactive management rather than a reaction to economic weakness. However, external factors, including a potential US recession, further escalation of geopolitical risks, or a shift in global risk sentiment, remain key downside risks and could outweigh any positive domestic factors.
Canadian Economic Fundamentals
Sustained Growth?
Second Quarter Strength, Monthly Questions: Canada's economy delivered solid growth in Q2 2024, with GDP expanding at an annualised rate of 2.1%—the strongest pace since Q1 2023 and exceeding market expectations (Statistics Canada). This growth was fueled by increased government spending and a surge in business investment, specifically in machinery and equipment. However, recent monthly GDP data reveals a pause, with zero growth recorded in August following a revised 0.2% increase in July. This slowdown, combined with a deceleration in household spending, raises concerns about the recovery's momentum. The BoC's own forecast of 1.5% annualised growth for Q3 suggests a more cautious outlook. The CAD could face headwinds if weaker economic data persists.
Inflation Cools, Food Prices Heat Up: Inflation in Canada has continued its downward trend, reaching the BoC's 2% target in August, marking a three-year low (Statistics Canada). This easing, primarily due to falling gasoline prices, strengthens the case for further rate cuts, potentially supporting the CAD. However, a rise in food prices to 2.8% in September indicates persistent inflationary pressures in certain segments. This mixed picture requires careful attention, as both the continued disinflationary trend and the stickiness of food inflation could sway the BoC’s future policy decisions and, consequently, the CAD.
Labour Market Uncertainty Persists: Canada's labour market presents a mixed bag. September's unemployment rate, at 6.5%, surprised by falling against expectations of a rise (Statistics Canada). However, employment growth has been volatile. The 46,700 increase in September contrasts sharply with the 2.8k decline recorded in July. Moreover, wage growth has shown moderation, reaching 4.6% in September. These mixed signals introduce uncertainty regarding the labour market’s health and create complexities for the BoC’s policy outlook, making it a key factor to monitor for its potential impact on the CAD.
Sentiment Improves, Global Risks Remain: Both consumer and business confidence in Canada have seen improvement. The Ivey PMI surged to 53.1 in September, signalling expansion, while consumer confidence rose to a six-month high in August (Ivey Business School, ANZ-Roy Morgan). This positive shift could potentially translate into stronger domestic demand, lending support to the CAD. However, global economic anxieties, particularly about the US economic outlook and geopolitical risks, remain prominent. The extent to which this optimism can persist against a backdrop of global uncertainty will be a key driver of the CAD's strength in the near term.
Upcoming Key Economic Releases: Key economic data releases in the upcoming week (October 16-25) include Housing Starts (October 16th), and August Retail Sales MoM (October 25th). The BoC’s Interest Rate Decision, Monetary Policy Report, and press conference on October 23rd will be crucial for understanding the central bank's outlook and its potential implications for the CAD.
Bank of Canada Monetary Policy: Data-Driven Decisions
BoC Holds Steady, Eyes Data: The BoC's current monetary policy stance is cautiously dovish. After implementing three 25 bps rate cuts, resulting in a policy rate of 4.25% as of September, Governor Macklem's communications suggest a likely pause (Bank of Canada). The central bank has adopted a data-dependent approach, focusing on incoming data, particularly inflation and retail sales. Concerns about overtightening, evident in discussions from recent meeting minutes, further emphasise this cautious approach. This data-driven posture adds uncertainty to the CAD's outlook, with potential reactions to economic data and shifts in market expectations for the BoC's next move becoming crucial factors for forex traders.
Intermarket Outlook
Bond Market Sensitivity: Canada's 10-year bond yield currently hovers around 3%, reflecting market anticipation of more BoC easing. However, the pace and extent of future rate cuts remain uncertain. The bond market will be particularly sensitive to the September and October inflation figures, with subdued inflation possibly driving yields further down and potentially weighing on the CAD.
TSX's Bullish Run: The S&P/TSX Composite Index has shown continued strength. Driven by gains in commodity producers, financials, and technology, this bullish momentum reflects market optimism about the Canadian economy. However, the TSX's sensitivity to global risk appetite and commodity price fluctuations warrants caution, highlighting the potential for external factors to impact the currency and market sentiment surrounding Canadian equities.
Commodities: Oil's Uncertain Path: Oil, a major driver of the Canadian economy, has seen price fluctuations in recent weeks, with WTI crude trading between $67.000 and $77.000 per barrel (Trading Economics). This volatility stems from geopolitical tensions, OPEC+ decisions, and concerns about global demand, creating uncertainty for the CAD. While a sustained increase in oil prices could support the loonie, further declines could weaken the currency, making oil's price trajectory a crucial factor for forex traders to monitor.
Geopolitical Landscape: Stability at Home, Risks Abroad
Canadian Political Stability: Canada's domestic political landscape is currently stable. The federal government remains focused on economic recovery and various social programs. The upcoming parliamentary session is expected to address the implementation of the 2024 budget, particularly initiatives concerning affordable housing and clean energy. No immediate political risks are anticipated that could substantially impact the CAD.
Global Uncertainties: The ongoing conflict in the Middle East remains a prominent geopolitical risk, especially for Canada's energy sector. Further escalation could significantly impact oil prices, potentially creating volatility for the CAD.
Sovereign Strength: Canada benefits from low sovereign risk, thanks to strong institutions, political stability, and sound fiscal management. Consistent reaffirmations of Canada's AAA credit rating by major rating agencies reinforce this confidence, contributing to the CAD's stability and attractiveness as a safe-haven asset during periods of global uncertainty.
Loonie’s Fair Value and Outlook
Assessing the CAD: The Canadian dollar appears to be trading relatively close to its fair value against the USD. This assessment considers factors such as purchasing power parity, economic indicators, and interest rate differentials. However, this valuation is fluid and may change depending on the evolution of key economic data and the BoC's monetary policy decisions. Continued TSX strength, further rate cuts by the BoC, and easing geopolitical risks could boost the loonie. Conversely, signs of a deeper economic slowdown, weakening commodity prices, and heightened global uncertainties could exert downward pressure on the CAD.
The Loonie's Next Act
The CAD’s short-term outlook hinges on the interplay of domestic economic data, the BoC's policy direction, and broader global market sentiment. The coming week's releases of retail sales and inflation figures will provide crucial insights and likely introduce some volatility. While the TSX's record highs signal underlying strength in the Canadian economy, uncertainty surrounding the BoC's next moves and the impact of geopolitical events warrant caution.
Key Takeaways for Forex Traders
Data Dependency: Closely monitor Canadian economic indicators, particularly retail sales and inflation, for clues about the health of the economy and potential implications for BoC policy.
BoC Watch: Pay close attention to the BoC's communications, specifically the Summary of Deliberations after the October 23rd rate decision. These communications could signal shifts in the central bank's outlook and impact the CAD.
Global Risks: The evolving geopolitical landscape, particularly developments in the Middle East, could significantly influence oil prices and create volatility for the CAD. Assess the potential impact of these events on global risk sentiment.
Sources
Bank of Canada
Statistics Canada
Bloomberg
Trading Economics
Ivey Business School
ANZ-Roy Morgan