The Canadian dollar experienced a sharp rally from May through September as the Bank of Canada implemented a tighter monetary policy. This was somewhat negative for fed and feeder cattle prices. However, since early September, the Canadian dollar has deteriorated and I’ve received many inquiries over the past few weeks with regard to future market direction. Feedlot margins are quite snug and, therefore, operators need to be shrewd when marrying their currency positions to their balance sheets. I thought this would be an opportune time to discuss the factors influencing the market direction over the next four to six months.
Canadian government fiscal policy is negative for the Canadian dollar. Tax increases, ongoing government deficits and overall left leaning policies do not bode well longer term. Recently, the cancellation of the “Energy East” pipeline has also set a negative sentiment for Canadian dollar ownership amongst investors. The elimination of a $15 billion direct injection from private enterprise along with the multiple spinoffs removes the floor of the currency. This erodes confidence in future development of other infrastructure projects for Canada’s major industry. The Canadian dollar has no friends when major negative news such as “Energy East” comes to the forefront.
Canada’s trade deficit widened in August from the previous month to the fifth largest on record. Exports have fallen for the third consecutive month and are now down on a year-on-year basis. The merchandise trade deficit stood at a seasonally adjusted $3.41 billion, up from a revised $2.98 billion shortfall in July. This data suggests that the pace of economic growth has dropped sharply. It would not be a surprise if manufacturing sales continue to decline in upcoming months. Third-quarter GDP will probably come in near 2.5 per cent compared to the second quarter growth of 4.5. The unemployment rate will be relatively stagnant for the remainder of the year. There is no major stimulus from the government coming forward and government construction season is coming to an end. Canada added 10,000 jobs in September and the unemployment rate stood at 6.2 per cent. While there was a 102,000 loss in part-time jobs, there was a gain of 112,000 full time jobs. On a positive note, wages showed a year-over-year increase of 2.2 per cent. Given the current environment, it is hard to justify further strength in the economy over the next four to six months. The Bank of Canada has cooled its talk of further rate hikes with widening trade deficit, stagnant inflation and tempered growth projects. The wage increases are positive but this is the only factor that would warrant further interest rate hikes.
In the U.S., the trade deficit narrowed to US$42.4 billion on a pickup in exports. It is important to note that when merchandise and services are incorporated into the data, the U.S. runs a slight surplus with Canada. For the most part, if Canadian oil and gas exports improve, then the trade balance would be about equal. Trump and the Republicans are on the road for major tax cuts which will put U.S. businesses at a major advantage and this will cause the U.S. trade deficit to narrow further. Lower taxes will bolster inflation and enhance job growth. If we use the New Zealand example, lower taxes will also result in greater government revenue due to the spinoffs in the private sector and greater consumer spending. The U.S. unemployment rate fell to 4.2 per cent in September, although non-farm employment fell by a seasonally adjusted 33,000; average hourly earnings rose 2.9 per cent from a year earlier. The U.S economy is at the latter end of an expansionary phase but until economic data suggests slower growth, there’s no reason to expect a cooling period.
It appears that Federal Reserve Chair Yellen is leaning towards a rate hike in December and then two or three consecutive rate hikes in 2018. This should coincide with the Trump tax cuts and temper the upside in the equity markets. At the same time, the Federal Reserve is starting to liquidate its balance sheet of longer-term bonds. Talk in the industry suggests it will liquidate about 10 billion per month and build this up to 50 billion per month. Demand for long-term bonds is quite strong so this should not significantly affect the bond markets. Selling bonds drives down the price and increases the yield, which is actually somewhat positive for the U.S. greenback against other major currencies.
U.S. crude oil inventories appear to be declining. Longer term, if we continue to see stocks decline, the crude oil market could continue to strengthen and thereby support the Canadian dollar. Amongst world traders, the Canadian dollar has once again become a resource-based currency with price direction related to crude oil, metals and other commodities. Monetary policy has taken a back seat for the time being.
In conclusion, the current environment suggests that the Canadian dollar will have a difficult time sustaining any rally. Our largest trading partner appears to be pulling the Canadian economy along despite the left-leaning fiscal policy of the federal and Alberta provincial governments. Further rate interest rate hikes by the Bank of Canada and positive economic data would be needed to warrant any strength. I’m looking for the Canadian dollar to trade in a range from $0.78 to $0.815 over the next four to six months. I have a weaker bias in the next two-month timeframe.