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2021’s Full Circle in USDCAD - Global Exchanges

FICC Podcasts November 23, 2021
FICC Podcasts November 23, 2021

 

In this week’s episode, we discuss the rally above 1.27 and the evolution of the key fundamental drivers of this exchange rate.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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Greg Anderson:

Hi, welcome to episode 26 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. In this week's episode, my co-host, Stephen Gallo and I will be talking about this week's rally in dollar Canada above 1.27. And the evolution of the key fundamentals that tend to drive this exchange rate. The title for this episode is 2021's Full Circle in Dollar Canada.

Stephen Gallo:

Hi, I'm Stephen Gallo, a London-based FX strategist. Welcome to Global Exchanges presented by BMO Capital Markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York-based FX strategist. I'm Stephen's co-host.

Stephen Gallo:

In each weekly podcast like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets, like commodities.

Greg Anderson:

We strive to make this show as interactive as possible. So don't hesitate to reach out by going to bmocm.com/globalexchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates or subsidiaries.

Stephen Gallo:

Okay, for the record it's November 23rd, 2021. Welcome to episode 26 of Global Exchanges. Full Circle is right, Greg dollar Canada closed 2020 at 1.2714, and we're trading almost exactly at that level now as we start recording episode 26. I think it's important to remind listeners though that we spent most of the year below the 1.27 handle.

Stephen Gallo:

The year to date average for dollar Canada is about 1.25. Now, we spent all of last week's podcast, Greg, talking about the Euro, so this is the real, real hot seat for you. Take us through the themes of 2021 and tell us how we ended up here.

Greg Anderson:

Stephen, even with very little movement in dollar Canada this year, and basically it's a nine big figure range, we'll call it 1.20 to 1.29 for the entire year, there's still a million things to talk about. But to keep this podcast short, I want to just focus on the three traditional factors for dollar Canada, and that's oil, Bank of Canada policy, and then the movement of the so-called big dollar or US dollar index.

Greg Anderson:

So let's start with oil since it's Canada's number one export, and is traditionally highly correlated with dollar Canada. Last year's average for WCS grade crude was $28 a barrel and we were at 33 on New Year's Eve of 2020. In a succession of three waves, we have seen a tremendous rally in WCS in 2021. We're now at $58 a barrel, and we've been as high as 68.

Greg Anderson:

So we're up, let's call it 75% year to date. And the average for 2021 thus far is rounded 50 to $4 a barrel. So basically the average price of oil has doubled in 2021 relative to 2020. With that, Canada's run monthly trade surpluses in seven of the nine months that we have data for thus far, and it looks like Canada will run a full year current count surplus of about a half a percent of GDP. And if so, it would be Canada's first current account surplus since 2008.

Greg Anderson:

So I'll summarize by saying this oil theme has been a huge positive for the loonie, or at least it should have been.

Stephen Gallo:

Okay, now this is something I find intriguing, Greg. Correct me if I'm wrong, but I don't think our proprietary short term fair value model for dollar Canada has once had oil as its number one driver all year long, but yet it feels as if we focused on oil so much this year because of the scope of the rallying crude. So with that in mind, can you tell us how we should visualize or quantify the impact that oil has had on dollar Canada this year?

Greg Anderson:

Good point of about the model, Stephen. The model looks at a variety of financial prices, and evaluates their correlations with dollar Canada. And as you noted, not once has oil had the highest rolling three month correlation with dollar Canada out of the model's 12 factors.

Greg Anderson:

There have been several three to six week interludes where dollar Canada tracked oil closely, but then the relationship fizzled out. Here's a little fun fact. The simple correlation of dollar Canada with WTI grade crude this year is at minus 0.34. And that correlation should be a negative by the way.

Greg Anderson:

For the WCS grade, it's minus 0.28. And that's close enough, same thing. However, the correlation with dollar Canada and copper is minus 0.75. So more than twice as tight of a correlation. And we're talking about copper, which is a much less important export price for Canada.

Greg Anderson:

So yeah, based on that, the oil theme hasn't seemed to matter all that much in 2021. But I will say this, where the loonie is flat against the dollar this year, Aussie is down 6% and Kiwi is down 3%.

Greg Anderson:

I think that if the oil rally hadn't happened, the loonie would be down somewhere in the middle, so let's call it four to 5%. So, I'll admit, if you would've told me a year ago that we'd see an oil rally this strong, I would've said, okay, that's going to push dollar Canada below 1.20, and that didn't happen.

Greg Anderson:

However, what I think has happened is if there hadn't been an oil rally, dollar Canada probably would've gone to 1.35 and it did not, as it would have otherwise.

Stephen Gallo:

Okay, Greg, so we've got one of your three key factors nailed down. We've covered, or you've covered the oil price, which has rallied this year and impacted the Canadian dollar positively with support to the balance of payments. What about the impact of the Bank of Canada? Take us through that.

Greg Anderson:

The Bank of Canada made its first taper increment year ago, but as we entered 2021, it wasn't clear if the bank would continue to taper, particularly if the Fed didn't. And the outlook for the first rate hike was that it probably wouldn't happen until 2023.

Greg Anderson:

There was actually a possibility of a so-called micro cut priced into the front end of the curve. And the CAD denominated two year swap rate was at 0.50%, 50 basis points at the start of this year. Since then, we've seen what I would call a remarkably swift evolution of Bank of Canada policy.

Greg Anderson:

First, the bank tapered further in April, when that wasn't really expected. Then it tapered again in July, and then ended its bond purchase program completely in October. The market began pricing in rate hikes and Macklem hasn't pushed back.

Greg Anderson:

Now, we've got a first Bank of Canada rate hike priced in for March of 2022, and a two year swap rate of 1.62%. So call it up 112 basis points year to date. And that compares to a US dollar denominated two year swap rate that has risen only 67 basis points year to date.

Greg Anderson:

So in other words, the two year interest rate differential has moved about 45 basis points in CAD's favor this year. So I would just summarize the year in terms of the monetary policy fundamental by saying that we've seen an evolution of Bank of Canada policy that has been remarkably CAD bullish in 2021.

Stephen Gallo:

Okay, now this has the potential, Greg, to be the key question of the podcast, why isn't the CAD bullish monetary policy fundamental showing up in the price of CAD?

Greg Anderson:

As you might imagine, Stephen, I get this question from clients a lot. Here's what I've learned to say, the Bank of Canada monetary fundamental is showing up in the price of CAD on crosses. So CAD is up 10% this year against the Japanese yen, it's up 8% against the euro. Obviously those countries are oil importers.

Greg Anderson:

CAD is up 6% against key trade partner and fellow oil exporter currency, Mex Peso, and where rate hikes have already begun by the way. CAD is also up 6% against gold year to date. So I'm going to say this positive evolution in the monetary fundamental is showing up in the relative price of the loonie. It's just not showing up in the most common measure, which is against the green back.

Stephen Gallo:

Okay, Greg, so the dollar is king. Let's talk about the third fundamental factor you mentioned at the outset, the big dollar and to keep things simple, we'll reference the Bloomberg Dollar Index or the BBDXY that has a plus 5.8% return year to date. What's your story for this?

Greg Anderson:

Stephen, if you're asking for my story on why dollar has appreciated so much in 2021 and coming in a year when [inaudible 00:10:00] was so bearish late last year and at the start of this year, that's such a long discussion that it would take up a whole another podcast. In fact, let's plan on doing a podcast about that over the next few weeks. As it relates to dollar Canada, let me just say this and it's my key point, when the dollar index is flat or flat-ish, and so momentum over, let's say a 12 month period is less than 5% up or down, then it doesn't get in the way of Canadian fundamentals such as monetary policy and oil, but when you have substantial dollar momentum, which again, I'll define as more than plus or minus 5% in a rowing 12 month period, then all of a sudden that overrides everything.

Greg Anderson:

And in fact, on a rolling 12 month period now we're past plus 5% for the USD, the dollar is king, as you said. And so with that, these other fundamentals have somewhat been washed to the side. I would just say the loonie by holding flat against the dollar has in fact appreciated in trade weighted terms and substantially along some key axes. It's not completely alone, so the RMB has been there with it too, for example, but I'll call it a win for the loonie for the calendar year of 2021. Let's just park it there and leave the US dollar outlook for a forthcoming podcast over the next week or two or three.

Stephen Gallo:

That sounds good, Greg, the outperformance of the RMB, as you mentioned, both relative to G10 currencies and within the Asian space is one of the most important features of the FX market this year, in my opinion. And as you said, we should be looking at that in a bit more detail over the coming weeks. Let's wrap things up here for episode 26 until next time, and thank you for listening.

Greg Anderson:

Thanks for listening to Global Exchanges, listen to past episodes and find transcripts BMOcm.com/globalexchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode, you can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple Podcasts, Spotify, or your favorite podcast provider.

Greg Anderson:

This show and resources are supported by our team here at BMO, including the FICC Macro Strategy Group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:

This podcast has been prepared with the assistance of employees of Bank of Montreal, BMO Nesbitt Burns Incorporated and BMO Capital Markets Corporation, together BMO who are involved in fixed income foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally and not a research report that reflects the views of disinterested research analysts.

Speaker 3:

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Speaker 3:

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Speaker 3:

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Greg Anderson Global Head of FX Strategy
Stephen Gallo European Head of FX Strategy

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