In a generally downbeat week for financial markets, the Canadian dollar was one of the biggest downers. After setting sail on Monday at just above 1.25, the USD/CAD pair promptly tacked hard all week long to nearly a 3% loss, 1.29 on Friday morning. In the view of economists at the Bank of Montreal, a wide range of factors conspired against the loonie which are in rough order of importance as follows:

See: USD/CAD set to surge higher above the 1.30 level – ING 

A dimmer global outlook

The ongoing spread of the Delta variant continues to chip away at the global growth backdrop. To the list of global dampeners, we have to add the sorry developments in Afghanistan this week; the ultimate failure there creates another potential geopolitical flashpoint, is yet another weight on sentiment more broadly.”

Weaker commodity prices

“One of the biggest financial market victims of the Delta variant has been commodity prices. In particular, oil has been hit hard by the prospects of a slower return to normal, with WTI sagging more than $10 just since the start of August to $63. But note that even with the recent drop, the BoC’s overall commodity price basket is up about 20% since the start of the year, while the currency is down slightly over that period. So, there’s more at work than just softer commodity prices.”

Taper talk 

“The new news was that a small majority appeared to favour tapering to commence before the year ends. Of course, we can’t know if the “majority” includes Chair Powell; and recall that there are many (hawkish) voices in the regional banks who don’t always get a vote. So while the odds of a slightly faster tapering have risen, it will, of course, depend heavily on the next jobs report (or two), as well as coming inflation readings and just how deeply Delta dents real activity.” 

The Federal Election

“While Canadian elections don’t tend to make big lasting waves in financial markets, they can send ripples. And any uncertainty tends to be expressed most particularly in the currency market, perhaps contributing slightly to the loonie’s volatility. One quick curveball right away was the surprise result in Tuesday’s Nova Scotia provincial election, where the Progressive Conservatives won a majority, upsetting the ruling Liberals. While it’s unlikely that such a dramatic flip-switch could happen to national sentiment, it’s not impossible, so markets will be spying the polls a bit closer than normal.”

Thin markets

“With many key participants on vacation and/or perhaps not as fully engaged as normal, market moves can be exaggerated. Keep that in context amid the fast fall in the Canadian dollar, and some of its key commodity counterparts.”

Where do we go next?

“The CAD may well remain on the defensive as long as Delta continues to rage and likely through the election campaign (and maybe a few days longer). However, our one-year view still looks for the USD/CAD pair to firm moderately to around the 1.21 level. The main driver is expected to be a more complete global recovery, supported by a somewhat earlier tightening by the Bank of Canada versus the Fed.”

 

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