Canadian Dollar – Not Just an Oil Play

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There is a reason why three out of the top five most livable cities in the world are located in Canada. Slowly, quietly but most assuredly Canada has become one of the most successful economies in the G-20 universe. The country has been able to leverage its massive natural resources, a highly educated workforce and one of the most efficient, least corrupt bureaucracies in the industrialized world to produce some of the most consistent economic growth since the 2008 global recession.

That strength in economic performance has in turn produced a strong currency, with the Canadian dollar trading near parity against the greenback for most of the year. Although Canadian GDP growth has not been spectacular, it has remained respectable matching US’s 1.9% gain in Q1 of this year. More importantly, the Canadian economy has been a much better creator of jobs than its neighbor to the south generating nearly 150K new positions over the past three months. On a population equivalent basis the gains in Canadian labor markets would amount to nearly 1.5 million new jobs since the start of this year and should serve as a potent source of consumer demand going forward.

Not Just Oil

For much of the past decade investors associated the strength of loonie with the strength of the oil market. As one of the largest producers of crude in the world and as the biggest exporter to the US, Canada was viewed through the narrow prism of that one commodity. However, lately the correlation between oil and USD/CAD has weakened considerably. The very recent spike in WTI to $110/bbl and concomitant decline to $80/bbl have had much more muted impact on USD/CAD trade then one would expect with the loonie only giving up 4% of its value from its peak in early March of this year.

A key reason for why the price oil is no longer the sole determinant of USD/CAD direction is the fact that the Canadian economy has been able to successfully diversify away from its natural resource base to such sectors as high technology, finance and retail. This shift in GDP production has resulted in a much more balanced economic environment turning Canada into one of the most consistent economic performers in the industrialized world.

There is no doubt that the loonie will still be correlated to risk flows in the currency market. If there is an expansion in global growth it will most certainly spur greater demand for Canadian resources and will in turn lift loonie higher. However, at a time of great economic instability and lackluster global growth the Canadian dollar may also begin to attract safe harbor capital because Canada not only enjoys one of the healthier economies in the G-20 but also one of the soundest sovereign balance sheet as well.

Loonie a Safe Harbor Bet?

Canada has one of the best banking sectors in the industrialized world with some of the strictest regulation on record. Canadian banks are required to hold on to their real estate loans and as a result their risk procedures tend to be more stringent than their counterparts in US, Europe and UK. Canadian banks therefore are well capitalized unlike the many problematic banks in Europe and US. As a result the Bank of Canada has not seen its balance sheet balloon from inventory of bad credit. Canada’s budget deficit is miniscule 1.5% of GDP and the country plans on balancing its budget by 2015-2016 fiscal year. Contrast those numbers with the near 10% budget deficits in US, UK and parts of Southern Europe, and suddenly the Canadian currency begins to look attractive not only a play on global growth but as one of the few repositories of sound money in the industrialized world.

Little wonder then that one the savviest institutional currency investors in the world- the Russian central bank announced several years ago that it will begin to diversify part of its holdings into Canadian dollars. If the credit contagion that is sweeping European shores begins to spill over into US, and US credit comes under attack as global investors begin to balk at financing the country’s enormous deficit, the Canadian dollar may become an attractive alternative and its it value as a safe haven bet may surpass its reputation as a risk currency.

Boris Schlossberg
Managing Director

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