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Sticker Shock in USDCAD - Global Exchanges

FICC Podcasts April 27, 2021
FICC Podcasts April 27, 2021

 

In this episode, we discuss this week's move below 1.24 in USDCAD and some of its implications for Corporate Canada. We are joined by Brad Schruder, an FX Sales Specialist who works with Canadian corporations of various sizes across many industries.


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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 eight of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. In this week's episode, my cohost, Stephen Gallo and I, will be talking about this week's move below 124 the figure in dollar Canada, and some of its implications for corporate Canada. To get a bit more perspective on this issue, we will be talking with Brad Schruder, an FX sales specialist who works with Canadian corporations of various sizes across many industries. The title for this episode is Sticker Shock 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 cohost

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 be 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, it's affiliates or subsidiaries.

Stephen Gallo:

So here we are. It's the 27th of April. We're rolling through Q2 now. A couple of things to point out here, or a few things to point out, it looked like things were getting a little bit wombly the beginning of last week in risk appetite variables, but the end of the week, things seem to end on a firmer footing. And then just yesterday, I noticed that the MSCI World Index hit a new high for the cycle. Very interestingly, copper hit another high for the cycle and also a ten-year high. And then into this mix, we've got a toss in dollar CAD. Definitely some interesting price action there, which I know you're going to comment on, Greg. We dipped back into the 123s again for the second time this cycle. I guess in a sense we shouldn't be overly shocked because we know commodity prices and risk appetite variables are the top dollar CAD drivers right now. So I guess I have to ask you is risk appetite is what's in the driver's seat here, Greg?

Greg Anderson:

I'm going to say yes to that, Stephen, but also feel like I need to kill a false narrative first. That false narrative is that a massively hawkish Bank of Canada triggered the CAD rally, or is at least as primarily responsible for the CAD rally. Because of noise in the US dollar, the best way to identify a central bank effect is to look at crosses. For CAD, I like to look at the Euro CAD and Aussie CAD crosses. In Euro CAD, we were trading flattish between $149.50 and $150.50 week before last. Then on Monday of last week, a competitor bank published a report saying that the risk of the Bank of Canada not tapering QE was bigger than the market had priced in. This report helped drive Euro Canada from $149.60 on Monday's open up to, let's call it, $151.80, right before the BOC policy announcement on Wednesday.

Greg Anderson:

Then the BOC did exactly what had been signaling by tapering QE from $4 billion a week to $3 billion, and upgrading its forecasts to basically reflect reality. This did trigger an immediate collapse in Euro Canada from $151.80 back down to $149.90. But look, that's simply put us right back to where we were at the start of the week. And now here we are almost a week later and we're at $149.80-ish in that cross. So basically we haven't done anything in Euro Canada since the BOC. And I could go through a similar spiel on Aussie Canada, but I think I'll spare you. My bottom line is that, Stephen, you nailed it. The primary drivers for a dollar Canada moving below $124 are global equities and commodity prices, not some giant Bank of Canada surprise.

Stephen Gallo:

Very well said, Greg, and I'm really glad we got that cleared up. I think my next question would be related to the issue of pain points in dollar CAD. I probably should mention first that we dipped to a 123 handle earlier this year. So my question is the fact that we've been here before, does it make it any easier for various segments of the market to absorb?

Greg Anderson:

For the most part, I think the leveraged investor community is able to absorb the move because IMM data showed they were slightly short dollar Canada heading into the move from the 126 handle down to the 123 handle. For real money Canadian investors, and especially equity holders, yes, the dollar Canada move lower hurts them, but at the same time, US equities have rallied enough that there is an offset. So I'm going to say that the real money segment can swallow this move without a hiccup, but the segment I'm not sure of is corporate Canada. I'm not sure they were really ready for this.

Stephen Gallo:

Well, on that fine note, Greg, I think it would be a great idea to bring in an expert on corporate Canada at this point in the podcast. So we're going to bring in and offer a warm welcome to Brad Schruder, who is a BMO FXL specialists, working with Canadian corporations of various sizes across many industries in Canada. And I'm going to start with the first question. So Brad, the first question I want to ask you is what segments do you think of corporate Canada are the most sensitive to a big rally in the Canadian dollar, and why is that the case?

Brad Schruder:

Stephen and Greg, first, thanks for having me on the podcast. If I can share an anecdote from a very experienced Canadian corporate executive from few years ago, his comment with respect to big moves in the currency was essentially that he didn't care if it was going up or if it was going down, talking about the Canadian dollar. What he cared about was the risk management activities of his peers in that framework. And so I think I'd start there and say that the segments that are most at risk are really made up of industries that have long benefited from the weaker Canadian dollar in general. And so there, I'm talking about your small to medium size Canadian exporters that generally wouldn't hedge out either this term, or even at all, under the belief that the Canadian dollar will net net always generally be weaker against this US peer.

Brad Schruder:

The specific industries where we're seeing some sensitivity around a very rapidly appreciating Canadian dollar would definitely be resourced based on, say, the mining space, for example, is an area where they take a long-term view of risk management with respect to currency. The forestry sector has exposure there, although over the years they have diversified into the US is becoming less so of a factor, but as well, small manufacturing firms and even larger manufacturing firms that generally speaking might have some difficulty forecasting cash flows due to seasonality, or just due to the recent slowdown brought about by COVID would probably be the areas that I would say are most affected.

Greg Anderson:

So Brad, do you think Canadian exporters are under hedged or neutrally hedged relative to normal?

Brad Schruder:

I think, Greg, on the whole right now most Canadian exporters would be under hedged. The budget planning process for many of the larger firms takes place in the fall, and I don't think that the vast majority of risk management committees expected this sharp move in the Canadian dollar. And quite frankly, what it's done is left them with a little bit of analysis paralysis where just when they're wrapping their heads around hedging cashflows on a 129 handle, we're suddenly trading at 127 and a half. And that cycle seems to be perpetuating itself even now.

Greg Anderson:

So what if the belief shifted that next year, 2022, we're likely to mostly trade below 120? Is corporate Canada prepared for that?

Brad Schruder:

I think right now corporate Canada is struggling with the major question that we all are as global investors. And that is, are we seeing a true paradigm shift here in global economics where commodity prices will remain firm and the Canadian dollar will benefit from a broad sector rally as opposed to just the energy sector. Right now, I would suggest that that path is one that is almost a nightmare scenario, and hence is somewhat on the back burner. We have been seeing some of the more experienced names begin to lower their budgets and protect themselves accordingly, primarily by use of FX option structures that allow them to participate should we see an occasional turnaround.

Stephen Gallo:

And Brad, I'm wondering if we could take a little bit more of a broader perspective. If I were to ask you what you think some of the more important non-US dollar CAD cross rates are for Canadian corporates, and is there, do you think, a particular currency cross where corporates may be under or over hedged against CAD appreciation?

Brad Schruder:

That's a good question, Stephen. We've seen over the past few years, a number of Canadian firms, [inaudible 00:09:37] very active from an M&A standpoint into Europe and the UK. I would say when it comes to Euro CAD, it's primarily left-hand side flows, so Canadian corporates bringing back Euro denominated revenues. And in industries where, I would call them commanding heights industries, you're seeing essentially a fair amount of Euro cash flows hedged out to the market. Sterling is a little bit of a different story. Again, same hand side as the cash flow's left hand side, but due to the Brexit ambiguity, a number of entities decided to take no action for fear of making a mistake as far as that macro picture developed.

Brad Schruder:

The other important cross I would suggest that is on the minds of Canadian firms is CAD yen. Canadian companies, especially in the agriculture and food products, export heavily into Japan. And generally speaking, those cash flows are not hedged because Canadian firms are so tied to the underlying commodity price as well, and they view that as a bit of an offset. So those would be my three major CAD crosses where I would say there's the most activity. And to be fair, if I had to lump them all into a "are we over hedged or under hedged," the vast majority would be under hedged.

Greg Anderson:

We thank you, Brad, for coming with us on the podcast and look forward to bringing you back in the future.

Brad Schruder:

Thanks again for having me and best of luck with the podcast, guys. It's a great job. Thank you.

Greg Anderson:

Really good stuff from Brad. I'm glad we had him on. One thing that surprises me a bit from his answers is that he didn't mention a Canada- China cross in his top three, but I guess maybe Canadian firms transact with China in US dollars, so there isn't much exposure. But I do have to note that CAD strength and RMB strength have gone hand in hand over the past few days. With dollar RMB below 650, what are your latest thoughts there, Stephen?

Stephen Gallo:

Well, the first thing that comes to mind, Greg, on your great question is that CAD CNH hasn't really moved all that much. And that suggests that the one-to-one and a half move lower we've seen in dollar RMB is predominantly a dollar driven move. Okay, so that's the first thing. The second key factor is that the CFX CNY index is just drifting sideways. So there isn't really broad RNB appreciation taking place at the moment. And I think that reflects the macro backdrop in China. In other words, the central bank has been tempering the credit cycle, also known as normalizing policy. I guess the main point I want to make here is that a break of 645 on the downside in dollar CNH is possible with just a weak dollar on its own, but the going will probably be tougher in the absence of a strong RMB and a weak dollar working in tandem with one another.

Stephen Gallo:

So going forward, I think probably we could do much worse than come up with a few signals that are worth looking at to try and work out what the next move is going to be in dollar RMB. I think first and foremost, I don't think we're going to see significant RMB appreciation until equity markets in China firm up on a consistent basis. Secondly, if we start to see interest rate differentials moving steadily in favor of the RMB again, that may be a signal that China is reopening itself to more capital inflows again. So that would probably be another indicator of RMB appreciation in the works. And thirdly and finally, I think we need to see the CFX index convincingly back above 97 and staying there, indicative of the fact that the RMB is appreciating on a broad basis.

Greg Anderson:

I think we Should probably wrap it there. Thank you listeners for your time and attention. We normally podcast on Tuesdays, but next Tuesday, Stephen and I will be tied up with a panel that is part of BMO's Global Reserve and Asset Managers Conference. And then the following Tuesday, we will do our joint macro horizons podcast with our colleagues in US and Canadian rates. So we'll be back with our Global Exchanges FX podcast in three weeks time on Tuesday, May 18th. Thanks for listening to global exchanges. Listen to past episodes and find transcripts at 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 podcast, Spotify or your favorite cast provider.

Greg Anderson:

This show and resources are supported by our team here at BMO, including the FIC 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 00:00:14:48], Incorporated, and BMO Capital Markets Corporation, together BMO, who are involved in fixed income and 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. Notwithstanding the foregoing, this podcast should not be construed as an offer or the solicitation of an offer to sell or to buy or subscribe for any particular product or services, including without limitation, any commodities, securities or other financial instruments. We are not soliciting any specific action based on this podcast. It is for the general information of our clients. It does not constitute a recommendation or suggestion that any investment or strategy referenced herein may be suitable for you.

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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