Canadian dollar shows swagger as supercyclists board


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(Bloomberg) – Already one of the top performing major currencies this year, the Canadian dollar looks set to become a market darling for all of 2021.

At the heart of the loonie’s vast gains are demand for the country’s abundant natural resources, attractive yields, and proximity to the United States, where vaccine deployments and infrastructure spending are helping the country’s largest export market. Canada to regain a foothold.

Against this backdrop of reflation and trading and the relative calm of equity markets, the Bank of Canada has signaled that it will slow quantitative easing. This fueled the currency’s largest quarterly return in years against two safe-haven counterparts: the yen and the Swiss franc. Even against the dollar, which has defied gloomy forecasts to release its best quarter in a year, the loonie has risen more than 1%, and it is just behind the British pound for the title of best major currency so far this year.

“The Canadian recovery will be impressive in the second half of the year, with upward revised growth forecasts,” said John Velis, strategist at BNY Mellon, which is long in the loonie against the dollar. “Also, the global reopening will help commodities as we move through the year and we’ll see that commodity and oil currencies do well.”

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The loonie’s first quarter performance is unlikely to be a flash. According to Bloomberg data, the economies of the Group of 20 countries are expected to rebound this year, with the United States and Canada in the top five, with growth of 5.7% and 5.4%, respectively, according to Bloomberg data. As growth accelerates and major central banks remain accommodative for the foreseeable future, growing demand for commodities could support the currency well into the next year.

Although commodity prices and the loonie do not move together, the 21-day correlation between the Bloomberg Commodity Index and Deutsche Bank AG’s trade-weighted index for the Canadian dollar is greater than 70% and close to the peaks seen over the past five years. US President Joe Biden’s “green” infrastructure packages are expected to further support prices, with some analysts touting an impending commodities supercycle.

Philippe Jauer, fund manager at Amundi Asset Management, says Biden’s spending schedule will be bullish for the Canadian dollar and other resource-linked currencies. The administration is acting “quickly, massively and that’s what the market is looking for at the moment,” he said, adding that Canada’s export market would benefit.

Jauer follows a butterfly strategy that includes long bets on the dollar, currencies linked to commodities and short on the euro. It favors the Canadian dollar over most other G-10 currencies, with the exception of the greenback.

The combination of strong growth and subdued inflation is particularly attractive to fixed income managers. Headline consumer price inflation in Canada is around 1.1% per year – below 1.7% in the United States The five-year break-even inflation rate for Canada, an indicator of bond market expectations for consumer price gains, is around 1.9% compared with around 2.6% for a similar US measure.

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Since Canadian government yields to maturities of less than five years exceed those of their US counterparts, carry yields are comparatively attractive. Among higher yielding countries, Canada’s favorable sovereign ratings and limited US dollar funding concerns make it an attractive alternative to many emerging market peers.

Not everyone is optimistic about the loonie. For Bipan Rai, strategist at the Canadian Imperial Bank of Commerce, the story of global growth is already being taken into account and he predicts a weakening against the greenback as markets revalue central bank policy. “To put it simply, we don’t think the Bank of Canada will beat the Fed when the pressure hits after 2021.”

There are also risks to the growth outlook, including the potential failure of vaccines to curb the pandemic and the challenges Biden will face in getting his spending plans approved. But for now, the markets are betting on a better outlook.

The one-year implied volatility of the Canadian dollar fell last week to its lowest level in more than a month – a sign that options traders are feeling more comfortable with the long-term stability of the loonie. Technically, the loonie is flirting with the main long-term hurdles against the US dollar, euro and yen. Against the greenback, a double-top, falling-wedges pattern since March 2020 is slowly approaching a 2015 support line at around C $ 1.2280 per dollar, from its current level of around $ 1. CAN $ 2,578.

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It is a level to test this year, if Greg Anderson of the Bank of Montreal is right. He has a year-end outlook of C $ 1.22, which would be the strongest since 2017, and sees yield spreads helping guide the way. Canadian two-year rates still exceed the equivalent of US debt by almost 4 basis points and those of their German counterparts by more than 93 basis points. Canadian yields have largely kept pace with Treasury rate hikes, which has pushed the loonie higher on many crosses, Anderson said.

“The yield differential that has opened up will create a little more appeal for the loonie on the crosses,” he said. “And that should help him outperform.”

© 2021 Bloomberg LP

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