USD/ CDN$ outlook

Goldman Sachs recently reiterated their previously correctly predicted call for a lower USD vs. the basket of world currencies.

Reasons for the bearish outlook came down to two main factors:

1. Goldman sees a “Robust case for improving European growth in coming quarters and stimulus from China.”
2. Goldman says “US  rates are high compared with a trade-weighted average of G10 nations rates.” As I interpret this, the fact that US rates are relatively high compared to other G10 nations, the US has plenty of room to reduce rates relative to other nations. Lower rates theoretically make treasury bonds less attractive, and is USD bearish.

The chart below is an interesting one. It show us how the USD vs. a world basket of currencies (black line) had been declining aggressively since 2017. It also shows us that this decline had been divergent to the S&P 500. In the past, as you might note on the chart, there are many periods of USD/SPX divergence. But I’d like you to also note what happens after each period of negative divergence (noted by black trendlines and circled areas on the correlation study at the bottom). Do you see how this negative correlation DOES NOT LAST?!? Can you also see how, more often than not, they reverse in correlation? This may, just may, imply that the USD may eventually reverse back to a bullish state, and the SPX, eventually, may reverse into a bearish move. Its already starting to look like the USD is leveling off. Food for thought. Anyhow, back to just talking currencies…

Why this matters

If you are like me – you hold some US stocks. Perhaps you hold them in a USD account, which “hides” the impact of those holdings on your overall performance in Canadian dollars. At ValueTrend, our USD holdings are held in our CDN$ platforms – which does not “hide” the swings in the dollar. It works both ways. We got the benefit of a rising USD up until 2017 on our platform. But since then –  particularly this year – especially in the past month or so, we- and other Canadians holding USD securities have seen a  3.5% negative return on the US/CDN currency exchange.

So – for us Canadians, the impact of the rising loonie has significant impact – even if you are not seeing that impact by holding a separate USD account. Its still there, and its still important.

So, we need to look at the CDN dollar compared to the USD. Analyst Larry MacDonald of Bear Traps, who I have quoted on this blog before, is bearish about the Canadian economy in the mid-long term view. He’s not alone- TD Bank and CD Howe have forewarned about the Canadian debt (personal and government) along with a pressured business  environment – and how these factors will pressure the Canadian economy.

Most of the reports I read suggest that even with a declining USD worldwide – the case is even more bearish for the loonie. However, the charts might argue this point of view right now. Note the breakout from the declining trend channel on the chart below – AND note the break of the larger downtrend line (big red line). It’s pretty hard to ignore this breakout—driven in part by a soft USD, but also by the Iran oil sanctions. Recall that our loonie is very much tied to oil prices. And oil is up on the concerns surrounding Iran.

The question will be – will the current breakout for the loonie continue, backed by strong oil and weakening USD? Hard to say. But for now, the trend is for a stronger loonie so long as those two conditions remain intact. As Goldman notes, above, suggest that the USD may continue to soften for some time. And, at least at this point, Iran doesn’t seem to be ready to compromise with the west either. Thus, I’d look for a bit more strength on the CDN$ for at least the near-term. Seasonality weakens after the fall for the loonie.  From there, its anyone guess as to how the USD and Iran conflict will play out over the winter. Should those two factors resolve, it may be enough to push the loonie back into bearish territory – per the analysts longer termed concerns noted above.