All Eyes are on Canada


Take a guess on the best and worst performers amongst major currencies against the US dollar this year. The answer may surprise you: the Mexican peso is the best performer while the worst is the Canadian dollar. Very much the opposite scenario compared to what we were seeing six months ago.

 

After a very difficult 2016 for the Mexican peso, losing almost 20% of its value against the USD on the back of Trump’s fearmongering about the Mexican wall and trade sanctions, the peso has recouped a great deal of the losses and is now trading at a 9-month high. On the other hand, the Canadian dollar, one of the best G10 performers against the US dollar last year, is now trading at a 22-month low. What’s the story here? Did the markets overestimate the Trump risk for the Mexican economy while underestimating the risk for the Canadian? Or are we seeing the start of a big downward trend for Canada?

 

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Amid fierce criticism about the lack of accomplishments during his first 100 days in office, Trump provoked critics even further last Thursday when he backed away from his pledge to cancel the NAFTA, claiming (on Twitter, obviously) that he will renegotiate the terms of the agreement and expects a high chance of reaching a deal given his “good relationship” with Enrique Peña Nieto, Mexico’s president, and Justin Trudeau, Canada’s prime minister. However, on Friday, the USA unexpectedly decided to impose tariffs of up to 24 per cent on softwood lumber imports from Canada and gave hints that the tariffs could be expanded to dairy products. The Loonie depreciated about 1% against the US dollar over the week.

 

Adding to the mix of bad news is the decline of Home Capital Group, Canada’s largest alternative mortgage lender, following claims that mortgage brokers working with Home Capital Group had falsified information on loan documents, allowing mortgages to be underwritten to highly risky borrowers. HCG was forced to agree to a very expensive $2 billion credit line from an institutional lender to rescue its short-term liquidity. Although this might just be an isolated incident, it may also be the initial hint of a larger problem – let’s not forget the Canadian real estate market has been making the headlines for a while due to its bubble-like prices (almost 35% inflation in Toronto house prices last year). All too similar to the US in 2005 and the initial events that preluded the Lehman Brothers collapse, many investors are now saying.

 

The trade war with Canada shouldn’t be a surprise. From the very beginning, the Trump administration has made it clear that it associates US trade deficit with slow economic growth and job losses, although this logic is disputed by economists, and urged officials to come up with a solution to the US trade deficits with other major economies such as Canada, China and Japan. Adding to that is the fact that the US has long been convinced that Canada is subsidising its lumber and dairy industries. So maybe analysts have indeed miscalculated the Trump risk for Canada and markets are adjusting to that. However, if the CAD decline is linked to the growing probability of a soon-to-be-popped housing bubble, this is a scary prospect due to its high risk of contagion, as we all remember very well from 2005.

 

So far, our bearish view on the Canadian dollar has been proved right and our USDCAD forecast remains unchanged at 1.40 by Q1 2018, however we will keep close attention to anything else that could muddy the charmed waters of the Canadian economy over the next few months. Maybe this is just a bump, or maybe we will soon see the end of the Volatility Spring (i.e. low volatilities and currencies trading sideways) markets have experienced over the past 5 months – see our 10th April article on this topic here.

 

Author: Marilia Shewchenko



 

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