Canadian Dollar: Central Bank Optimism Gives Currency A Fresh Boost

Currency markets were excited for less than an hour over the latest Monetary Policy Report (MPR) from the Bank of Canada. Before the dust settled, USD/CAD, the Canadian dollar versus the U.S. dollar, reached a near 3-year low. Economic optimism from Canada’s central bank gave the Canadian dollar a fresh boost.

USD/CAD at one point reached a level last seen April, 2018.
USD/CAD rushed downward for about an hour before bottoming. It drifted higher and then lower before rebounding off a fresh multi-year low.

Bank of Canada Governor Tiff Macklem delivered relatively upbeat news about the Canadian economy despite a negative forecast for Q1 GDP growth. The Bank of Canada is looking past the current lockdown-driven slowdown to a coronavirus vaccine rollout that places Canada’s immunity profile 6 months ahead of schedule. As a result, the Bank of Canada upgraded its forecast for overall GDP growth in 2021 to 4%. Growth should tick up to 5% in 2022 and moderate in 2023 to 2 1/2%.

Even with the upgraded forecast, the Bank of Canada remains very cautious. It wants to maintain highly accommodative monetary policy:

“…there is clear reason to be more optimistic about the direction of the economy over medium term. But we are not there yet. The resurgence in COVID-19 cases weighs heavily on the near-term economic outlook. And this underlines the ongoing need for extraordinary fiscal and monetary policies.”

A member of the press asked Governor Macklem about the impact of the strength of the Canadian dollar. He recognized that “further appreciation” represents a real risk to the Canadian economy. However, he also conceded the Bank cannot lean against USD/CAD because the relative strength of the Canadian dollar is about “broadbased” weakness in the U.S. dollar. From the very end of the MPR:

“The Canadian dollar has risen steadily since October, reaching its highest level since early 2018. This increase has been driven primarily by broadbased weakness of the US dollar. Appreciation of the Canadian dollar creates direct downward pressure on inflation by lowering the prices of imports. Further appreciation of the Canadian dollar could slow output growth by reducing the competitiveness of Canadian exports and import competing production. Slower output growth would also imply more disinflationary pressures.”

The currency momentum likely helps explain the Bank of Canada’s readiness to add yet more stimulus to the economy if needed: “We agreed that if the economy turns out to be substantially weaker than we are projecting—leading to more disinflationary pressures—then we have options to add even more stimulus. And we are prepared to use these options as needed.”

The Trade on the Canadian Dollar

Since hitting a 4-year high at the bottom of last March’s stock market crash, USD/CAD has more or less consistently trended downward. The 20-day moving average (DMA) serves as a sufficient pivot given the persistence of the downtrend.

I have been bullish on the Canadian dollar throughout the pandemic. Canada’s approach to managing COVID-19 risks gave it a GDP advantage over the U.S. starting last summer. After taking profits on my latest trade in the wake of the Monetary Policy Report, I am looking for the next bounce to fade.

Newly inaugurated U.S. President Biden presents a new wildcard for the trade on the Canadian dollar. Biden’s plans for aggressive fiscal policy and massive deficit spending could supercharge growth in the US. Biden’s success could eventually bottom out the U.S. dollar. Still, I do not think the market is yet willing to bet on such a prospect.

Be careful out there!

Full disclosure: no positions

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