In our December column we labelled the NZD/CAD as “The Big Short.” The pair fell 6% from its November highs and by mid-December it was the highest returning combination among the G10 currencies.
It is widely known the U.S. dollar has strengthened significantly since Donald Trump’s victory in the U.S. presidential election. But do you know which currency is the strongest in 2016 through Dec. 15 among the currencies of the largest 10 nations? It is not the U.S. dollar or the Japanese yen; it is the Canadian dollar, though the largest gain occurred in the first half. Since the start of 2016, the loonie is up 19% against the U.S. dollar, 8% against the euro, 7% against the Swiss franc, 5% against the Australian dollar and 1% against the yen and the New Zealand dollar. More importantly, the loonie is not only the best performer since the start of 2016, but also the best performer since the start of Q4.
The 40% plus recovery in crude oil prices since early 2016 played a major role in the rebound of the Canadian dollar. But the loonie story is more than just oil. Remember when oil had plunged to 13-year lows at $26 per barrel in January 2016, or four months later when wildfires struck in the province of Alberta destroying 1.5 million acres, making them the costliest disaster in Canadian history? In neither case did Bank of Canada governor Stephen Poloz cut interest rates. Those developments reflected a powerful act of foresight from the central bank in the face of economic challenges. Although Canada’s main overnight interest rate is at 0.50%, just an eighth higher than the U.S. Fed Funds target prior to the December tightening and an eighth below after, do not be surprised to hear rumblings of a Canadian fiscal stimulus ahead of the United States.
And while there is so much optimism in financial markets and in the U.S. dollar about the expectations of a long-awaited fiscal stimulus, Canada is already ahead of the United States in this respect. Canada has cut interest rates for lower- and middle-income earners as well as implemented higher infrastructure spending in early 2016 under President Justin Trudeau, who was elected in November 2015. It is not clear when or to what extent President-elect Donald Trump will succeed in passing $1 trillion in infrastructure spending.
Don’t be so sure the Canadian dollar strength is dependent on the oil price recovery. Bank of Canada’s Stephen Poloz said in the fall of 2016 that the pullback in Canada’s exports figures may be misleading because companies have been increasingly building plants abroad, with sales by Canadian-owned foreign affiliates nearly matching exports sold from Canada, at C$510 billion versus C$573 billion. Poloz implied that “there is almost as large a Canadian economy operating in foreign countries as there is in the domestic export sector, creating jobs and GDP both domestically and abroad.”
Aside from a renewed decline in energy prices, one other familiar threat remains in Canada, namely, soaring household debt to after-tax income, which hit a new high of 167%. This becomes especially relevant if bond yields continue escalating.
So, against which currency is the loonie’s best potential to gain? Aside from shorting NZD/CAD to target 0.85 territory, taking a short in GBP/CAD is a viable alternative. As the UK enters Article 50 negotiations with the European Union over Brexit, expect a messy and divisive process in the UK, alongside an increasingly solid position in Brussels aimed at discouraging other European nations to consider leaving the EU. Although GBP/CAD fell for four consecutive quarters, any rebound towards the 1.72-1.73 territory is likely to be sold and drive the bears towards the 1.60 trendline support. A break below that level opens the floodgates to the 2013 low of 1.5240.