During the early part of the year, the loonie’s dive became a concern for the Bank of Canada. But the central bank is now faced with the opposite problem. CAD has gone from worst to first among G10 currencies over the past three months and is fast approaching levels that would jeopardize the rotation in the domestic economy toward non-energy exports and investment. The currency’s appreciation has partly come on the back of higher oil prices, with WTI trading above $40 again. But the loonie’s strength also reflects changing monetary policy expectations. Better-than-expected readings on the economy combined with the effects of fiscal stimulus have seen the market price out the possibility of a BoC rate cut, while a soft patch in US economic data and dovish Fedspeak have reduced interest rate differentials further. That said, the best is likely behind for the loonie.
The Bank of Canada took aim at the currency in its most recent rate announcement by saying that the outlook for non-energy exports was weaker as a result of the stronger Canadian dollar and it can be expected that the Bank would use firmer language if the currency continued to gain ground on its US counterpart.
Moreover, oil prices are likely to be less one-directional in the next few months. The oil market isn’t expected to return to balance until much later in the year. Moreover, some Canadian economic data releases are already beginning to show that the strength observed earlier in the year was at least somewhat attributable to transitory factors. Look for the loonie to weaken as domestic data underwhelms and US data begins reflecting more of the gains seen in employment recently. However, CAD will regain some of its losses as 2016 comes to a close.
Oil prices should move sustainably higher as both the oversupply is reduced and global demand accelerates. As a result, 2017 should see the CAD trend between 1.30 and 1.35 versus the USD as the Fed continues to the take a gradual approach to tightening policy.
CIBC targets USD/CAD at 1.32, 1.37, and 1.34 by the end of Q2, Q3, and Q4 respectively.