Canadian fed and feeder cattle prices have been enhanced by the weaker exchange rate since oil prices crumbled back in the spring of 2014. At that time, the Canadian dollar was highly correlated with crude oil values. The Canadian election in 2015 contributed to the softer currency as the Liberal fiscal policies were negative for the Canadian economy. This is one of the few governments in modern history that raised taxes and raised the deficit at the same time.
Investment into the Canadian resource sector suffered and capital was flowing into more lucrative economies such as the U.S. When President Trump took office, the positive fiscal policies of personal and corporate tax cuts caused equity markets to soar to fresh record highs. These tax cuts, combined with fiscal stimulus in infrastructure along with deregulation in government red tape for resource development, attracted capital from around the world.
The U.S. Federal Reserve was concerned about inflation and started raising rates in December of 2015. On December 19, 2018, Chairman Powell made the ninth increase resulting in the Federal Funds rate growing from 2.25 per cent to 2.50 per cent. While the Federal Reserve was raising interest rates, the Bank of Canada kept their rate 0.75 per cent from July 15, 2015 to July 12, 2017. The premium of U.S. bond yields over Canadian bond yields was increasing thereby keeping pressure on the Canadian dollar. Since July 2017, the Bank of Canada has made five upward adjustments of 25 basis points. The Bank of Canada rate is now 2.00 per cent. Bank of Canada Governor Stephen Poloz has stated he is not eager to lower rates and the current rate of 1.75 per cent is appropriate for the improving economy and the bank’s goal of realizing steady inflation. At the time of writing this article, the U.S. Federal Reserve rate was 2.50 per cent and Chairman Powell has stated a rate cut is likely at the end of July and then again potentially at the end September. The U.S. interest rate premium over the Canadian rate is now eroding. The U.S and Canadian central banks could have a similar rate by the end of the year.
The U.S. bond yield premium over Canadian bond yields is eroding. The Canadian dollar dipped to a low of 73.75 U.S. cents on May 31. On Friday July 12, the September Canadian dollar closed at 76.65 U.S. cents which is a gain of 3.9 per cent. The narrowing of the interest rate spread between the U.S. and Canada is positive for the Canadian dollar. We now find the Canadian dollar entering a new fundamental trading range.
On July 10, U.S. Federal Reserve Chairman Jerome Powell testified before Congress. He stated a rate cut was likely at the end of July and one more cut should be expected by the end of 2019. U.S. inflation is too low and this could hurt the economy longer term. The U.S. labor department stated that the consumer price index increased 1.6 per cent in June from a year earlier, which is down from 1.8 per cent in May. Core inflation, which excludes food and energy, was more constructive, experiencing a month-over-month gain of 0.3 per cent and a year-over-year gain of 2.1 per cent. Chairman Powell’s “light bulb’ moment came when he stated that the relationship between unemployment and inflation “has gone away.”
The U.S. is in a new era where the U.S. contends with self-sufficiency in oil and becomes a major exporter. In the past, strong energy prices were synonymous with strong equity markets. Energy prices increased as equity markets rallied enhancing inflationary pressures. We now find that lower U.S. gas prices are a main factor contributing to the weaker inflationary data. Average hourly wages were up 1.5 per cent from a year earlier after adjusting for inflation. Two months ago, Chairman Powell stated weak inflation was due to transitory factors; however, the U.S. is increasing oil production and weaker energy values may be here for some time. Bank of Canada Governor Stephen Poloz reflected a neutral to dov-ish tone at the July meeting; however, there was no signal that the Bank of Canada would follow its U.S. counterparts with rate cuts.
In conclusion, the U.S. monetary policy is dov-ish while fiscal policy is neutral. In Canada, monetary policy is neutral while fiscal policy remains negative. There may be some hope on the fiscal front with the federal Conservatives leading in the polls. In most cases, currencies don’t like uncertainty and tend to weaken until election time. I’m looking for minor strength in the Canadian dollar over the next couple of months. By the end of the year, we could see the Canadian dollar near 80 U.S. cents if the Bank of Canada leaves its target rate unchanged at 1.75 per cent and the U.S. Federal Reserve lowers its target rate to 1.75 per cent to 2.0 per cent.