Trading The 'Loonie'

The Canadian Dollar, or as it’s colloquially known, the Loonie – the nickname of the native bird adorning one side of the dollar coin – can prove to be a rewarding trade against the US Dollar. The two countries each see a significant volume of trade with one another and since the mid 1980’s, Canada has actually held a modest deficit when it comes to the trade of physical goods with its southern neighbour.

The close economic association between the two nations means that modest macroeconomic deviations, especially in terms of Canadian data, can create some well telegraphed trading opportunities on the USDCAD cross. What’s more, the market is also recognised as typically having limited liquidity, thereby having the potential to exaggerate the resulting moves.

Arguably the most obvious factor to watch for will be divergence in yields between USD and CAD denominated deposits, or in other words the interest rate outlook from the Bank of Canada versus the Federal Reserve. Both hold the prized Aaa credit ratings so there’s arguably little else to consider when it comes to risk. The charts below illustrate the close correlation in central bank borrowing rates between the two countries, so where divergence is seen, expect movement in the underlying currencies to follow.

***Trade opportunity*** If central bank outlooks start to diverge, buy the hawkish currency and sell the dovish one.

The Federal Reserve has made no secret of the fact that it will now take an exceptionally patient line when it comes to thinking about a further rate hike. Critically, the Bank of Canada has said essentially the same, downgrading the country’s economic growth prospects as a consequence of falling oil prices. For now, trading off monetary policy divergence may need to be side-lined for a while.

Oil prices

Oil and other fuel exports account for around 20% of Canada’s foreign currency income. That’s an abnormally large weighting for any currency, meaning that price swings in the crude market have the ability to impact the value of the Canadian dollar. Typically that means when demand exceeds supply in the global oil market, the Canadian dollar will appreciate. One interesting diversion was however seen here in 2016 in the wake of

extensive oil sand fires in Canada. Rising oil prices had driven USD/CAD down to a 10 month low by the end of April, before the fires started, driving the pair 5 cents higher in a matter of days. The political stability of Canada means such supply shocks are rare, but in this instance, Canada was unable to help meet the rising demand.

***Trade opportunity*** Look for shifts in supply data such as the weekly crude oil inventory data from the US. In the vast majority of instances, rising oil prices should bolster the Canadian dollar

Canadian PMI

Unlike many other major economies, Canada produces one consolidated PMI reading, calculated by the Ivey Business School and released on the first Wednesday of each month. The fact this is delivered in a single release, rather than splitting between services and manufacturing clearly has an increased bearing on the Bank of Canada’s monetary policy outlook. Although the current forecasts put this reading heading lower in the months ahead, any deviation from this would have the potential to see interest rates edging higher.

***Trade opportunity*** If PMI comes in above expectations, CAD appreciation may follow, amplified in the short term by potentially thin underlying liquidity.

Factors such as political stability, a high credit rating and a seemingly consistent trade deficit in recent years remove many of the potential uncertainties for the Canadian Dollar. Yes, trade overtures from their neighbour to the south may be a cause for concern, but as has been noted already, Canada typically imports more goods from the US than it exports. Removing these extraneous factors means that USD/CAD has the potential to offer some well signposted trading opportunities - with a fair degree of regularity.