Harapyn about the shifting dynamics for the U.S. and Canadian dollars.

The Federal reserve has suggested that inflation has eased but is still elevated. Let’s talk about what happens now the U.S. dollar, to the Canadian dollar.  

I think that the key point in that sentence there is the prior language in the statement that came out in the last Fed meeting only said that inflation was elevated. In this case we’ve got an acknowledgement of easing inflation pressures in the U.S. economy. You know, it’s cautious optimism at this point, they’re not saying that inflation has come down in the sustained way. They’re not suggesting that they are going to react to that immediately, but they are are acknowledging that you are seeing that decline in prices. As so that brings the Fed into closer alignment with where the Bank of Canada is, but of course in Canada we are looking at an economy that is far more interest-rate sensitive and a central bank that has already taken the hawkish blinders off and is now positioned for a pause. 

Given that the language of the Bank of Canada recently suggested there would be a conditional pause and we are possibly in a wait and hold situation with the Federal Reserve, where does that leave the US dollar which we saw hitting record highs in 2022 and where does that leave the loonie?

I think the big story in currency markets globally here at least since September, maybe early October, has been the decline of the dollar. That has been coming on the back of a change in the dollar’s position in global markets. And so the Fed is now one of the less hawkish central banks globally, you still have the European Central Bank and the Bank of England hiking. We have fading in the energy shock and prices have come down, we have a fading in the impact on the European economy and we also have China reopening and lifting global demand expectations. So all of that has contrived to push down on the U.S. dollar on a trade weighted basis but the Canadian dollar has weakened in-line with that but the main reason is that the markets are worried about what happens to consumption in the Canadian economy, if we see housing continue to weaken. If the housing market continues to fall and rate increases that happened last year continue to feed through into household spending patterns, that could impact the Canadian economy. That could push the Bank of Canada toward cutting more quickly than the Federal Reserve across the border. 

You’ve mentioned some of the energy shocks, central banks and their policies, and the war in the Ukraine all responsible for those currency fluctuations. In the past you and I have spoken about how this is a fragile period in currency markets. Anything else on your radar that would be responsible for that?

To some extend those geopolitical shocks are moving to the sidelines. But I guess how I would characterize 2023 is it’s sort of the year of the whiplash. We are going to see the lagging impacts of the policy response last year hitting at most major economies. And what we do expect is non-linear trading mechanics which is sounds like a very highfalutin way to say it. We are looking at cases where currencies go in one direction and reverse and move in the opposite direction sort of on a dime. And then this is a huge contrast to where we were last year. Last year the U.S. dollar was powering higher and that was like an unstoppable juggernaut that everyone died trying to get out of the way of. So this year we are expecting to see sort of bull-whip effect, cases where we have over-optimism, like maybe where we are today, when everyone is thinking about a soft landing, and the risk sensitive currencies the Canadian dollar are outperforming. But we could also see a moment somewhere in the middle of the year where we have almost a Wiley Coyote moment and everyone looks down and realizes that maybe the underpinnings of this economy are maybe not so solid and we should protect ourselves.

We have talked about that new relationship between oil and the dollar. Do you think this changed relationship is here to stay or will it revert back to where it was before?

I don’t think we are ever going back to where we were there was a point there where the petrol loonie was clearly the dynamic if you talk to almost anyone in the world, especially in the currency market, the assumption was that the Canadian balance of trade and the Canadian economy were driven by crude exports.That has fallen apart in recent years, partly because the Canadian economy has shifted and most of the economy is being driven by domestic consumption but also partly by the fact that the U.S. has become a quasi energy independent. The U.S. has been able to participate this year as oil prices have risen, the U.S. has actually been an improvement in terms of trade. So we are no longer in this binary relationship where oil prices go up, the Canadian dollar goes up. At some point we’re likely to see correlations have improved from where they are but it’s not likely to be a major driver. 

The IMF recently upped its Global growth forecasts, what does that do for currencies around the world and specifically, the U.S. dollar?

The IMF in 2007 said that the global economy was going to essentially have clear sailing in 2008 and I think currency markets, traders, investors, most market participants, look at this with some skepticism. They do assemble their opinion looking at the data that is coming in and not necessarily IMF forecasts. However, the IMF is clearly reflecting an improvement, we are looking at global markets being driven by a sense of cautious optimism. We are looking at global markets that are more confident about what might happen later in the year and this is largely a function of the fact that we have seen labour markets essentially not moved, they are very very strong across most developed economies and the fact that inflation pressures are beginning to subside. This idea of a soft landing gained pretty significant exposure in recent weeks and that is driving currencies sort of onward and upward. This is really what is driving other currencies around the world up against the safe-haven dollar.

When you take a look trajectory of the U.S. dollar and the loonie for 2023, where do you expect them to land?

Initially I think we are going to see a little bit of strength here, I do think that the Canadian dollar is likely oversold on the fundamentals, we may have a boost of optimism coming down the pipe in the next couple weeks or months, but beyond that we do expect those domestic vulnerabilities to take over again. The fact that Canadian households are going to change spending patterns, we are going to see that ripple out to the rest of the economy and I think that that is going to drag the Canadian dollar down maybe another 3 or 4 cents from where we are today by the end of the year. We are looking at a non-linear environment here in which we do not see a clear trend emerging throughout the year and it could get very bumpy. 

Source: Financial Post