Canadian Dollar Forecast June 2015
The US dollar is back on track after taking huge losses in April. This trend has been fuelled by improving US economic data and diverging monetary policies across the globe. At its peak, USD/CAD was trading at little over 1.25 and it is expected to push higher pending further US economic data releases.
The Canadian dollar has seen a reversal in its April rally driven by a strong US dollar, weak Canadian economic data, and relatively weak oil prices. Further drops in the Canadian dollar can be expected if oil prices weaken in combination with a pessimistic Bank of Canada with regards to second-half year growth.
In monitoring USD/CAD, monetary policy, economic growth, and oil prices will be the main determining factors for the foreseeable future.
The Canadian dollar bears continue to hope the US economy strengthens in the second half of the year. Key data to look out for will be growth related to jobs, manufacturing, construction, housing, and consumer sentiment to name a few. Stronger US data will hopefully confirm expectations of a fall/winter rate hike causing money to flow into the US dollar while suppressing the Canadian dollar. As stated in the May outlook, all eyes remain on the Fed and the US dollar in determining the direction of the Canadian dollar. However, a growing driver has been central bank policy outlook as the Bank of Canada continues to monitor and assess data. The Bank of Canada seems to be on the sidelines and this will be required for the US dollar uptrend to take place.
There is little saving grace for Canadian dollar bulls with Q1’s GDP report showing contraction in output and build up in inventory which may limit production later in the year. Although much of Q1’s disappoint can be contributed to external factors such as weather and increased household savings, the Canadian economy’s largest driving factor remains to be oil prices. Oil prices have managed to improve slightly, however, are still at levels too low to significantly impact the economy if at all. As a result, and as indicated by the Bank of Canada, the economy remains heavily reliant on the success of the US economy. The Bank of Canada has further amplified this expectation by predicting an above-average growth rate of 2.7% for the second half of the year which may lead to further downside risk. Lastly, Canadian dollar bulls must consider the alarming current account deficit which has widened in Q1 to 3.5% of GDP due to poor oil prices and bad weather disrupting trade. Further concern can be found in the financing of this deficit mainly coming from unstable portfolio inflows rather than stable foreign direct investment which can lead to increased volatility in the Canadian dollar.
Summary
With the US dollar resuming its strong growth trend, the Canadian dollar is likely to fall if Canadian economic and growth data remains weak while foreign investment continues to be shaky. As stated above, the US Fed and US economic growth continue to be the main focus. Look for USD/CAD to remain between 1.23 and 1.27 in the near term however projections by year end go as high as 1.30.
Oil Prices
Oil prices have moderated, trading for the most part between $50/bbl and $60/bbl over the past several weeks. However, supply shocks from OPEC and the potential for increased drilling in the US, to capture current price levels, threaten to drop oil prices in the second half of the year. In the near term, the Canadian dollar continues to be highly correlated to oil prices; however, the Bank of Canada has begun to shift its focus onto the US recovery.
Canadian Economy and Bank of Canada
The Bank of Canada has continued with its positive tone but perhaps has painted too rosy of a picture by predicting an average of 2.7% growth for the second half of the year. The central bank, in its May statement, stated that it expected Q1 data to be weak but that Canada should rebound in line with the strengthening US economy. In contrast to the US, the Bank of Canada has maintained a neutral bias as we wait on signs of an improving Canadian economy.
Currently, the labour market is expected to add roughly 10,000 jobs per month in line with 2014 figures while the manufacturing sector continues to offset losses in the oil patches. Although business investment remains weak, vehicle sales continue to prop up relatively strong retail figures, while inflation has edged slightly above 2% due to pass-through effects from imported goods. Improving conditions in these areas will be necessary for a Canadian dollar rally.
US Economy and Federal Reserve
The US economy experienced contraction in early 2015 in response to pullbacks in energy sector spending. Although the latest data reports point towards moderate growth, expectations for strong performance in the remainder of the year continue. This can be seen in strong consumer confidence and spending and continued improvement in the unemployment rate, sitting at a seven year low of 5.4% in April. The Fed will continue to monitor US economic data and growth in deciding when to raise interest rates. It is likely that if the economy does as what is expected, the US dollar will rally towards the end of the year.