Analysts expect the Canadian dollar to reach 81.96 U.S. cents against the U.S. dollar by the end of the year, which would be the highest level since 2017. Already one of the top performing major currencies this year, the Canadian dollar is expected to be the most talked about currency in the market throughout 2021.
The Canadian dollar is widely bullish based largely on the country’s abundant natural resources, attractive production, and the market demand in the adjacent U.S. The advancement of vaccinations and infrastructure spending in the U.S. will help this largest export market for Canada regain its footing.
Stocks were relatively flat against a backdrop of deflationary trade, and the Bank of Canada said it would slow down its quantitative easing policy. The euro posted its largest quarterly yield in years against the yen and the Swiss franc. The Canadian dollar rose more than 1% against the U.S. dollar, second only to the British pound in this year’s ranking of the best major currencies.
The Coming Commodity Supercycle
“The second half of the year will see an impressive recovery in Canada, with growth forecasts revised upward,” according to John Velis, strategist at BNY Mellon. “In addition, global reopening will be positive for commodities, with commodity and oil-related FX set to perform well.”
The Canadian dollar’s first-quarter results are unlikely to be just a passing hot streak. The U.S. and Canada rounded out the top five, growing 5.7 percent and 5.4 percent, respectively, as the G-20 countries’ economies are expected to rebound this year, according to Bloomberg data. With the pull of economic growth, continued central bank easing for the foreseeable future and growing demand for commodities, the Canadian dollar will continue to receive favorable support next year.
Although commodity prices and the Canadian dollar have not moved in tandem, the 21-day correlation between the Bloomberg Commodity Index and Deutsche Bank’s trade-weighted Canadian dollar index is above 70%, near the highs of the past five years. U.S. President Joe Biden’s “green” infrastructure plan will further support commodity prices in what some analysts are calling the coming commodities supercycle.
Biden’s spending package will benefit the Canadian dollar and other resource-related currencies, said Philippe Jauer, a money manager at Amundi Fund Management. He said the government is “moving quickly and massively, which is what the market is looking for right now.” Canada’s export markets will benefit, he added.
Jauer follows a butterfly strategy that includes long bets on the U.S. dollar, commodity-linked currencies and short bets on the euro. He advocates the Canadian dollar against most other Group of Ten currencies except the U.S. dollar.
Strong growth and subdued inflation are particularly attractive to fixed income managers. Canada’s main consumer price inflation rate is about 1.1 percent per year, lower than the 1.7 percent rate in the United States. Canada’s five-year break-even inflation rate is about 1.9, a level that is an indicator of bond market expectations for consumer price inflation. This compares with about 2.6 percent in the United States.
Arbitrage returns are relatively attractive because the Canadian government’s five-year Treasury yield is lower than that of its U.S. counterpart. Among high-yield countries, Canada’s good sovereign rating and limited concerns about U.S. dollar financing make it an attractive alternative for many emerging market countries.
Different views on the Canadian dollar’s movement
Not everyone is optimistic about the Canadian dollar. Bipan Rai, a strategist at Canadian Imperial Commerce, expects the Canadian dollar to weaken against the U.S. dollar as the market reprices central bank policy. “In short, when pushing for a post-2021 rate hike, he believes the Bank of Canada will not raise rates ahead of the Federal Reserve.”
There are also risks to the growth outlook, including the possibility that vaccines may not contain the pandemic and the challenges Biden will face to approve his spending plan. But for now, the market is betting on a brighter outlook.
The one-year implied volatility of the Canadian dollar plunged to its lowest level in more than a month last week. This suggests that options traders are increasingly comfortable with the long-term stability of the Canadian dollar. Compared to the U.S. dollar, it has slowly approached its 2015 support line of about 81.45 cents since March 2020 from its current level of about $79.77.
If Full Bank’s Greg Anderson’s forecast is right and his year-end outlook for the Canadian dollar is 81.96 cents U.S., then this would be the highest level since 2017. Canada’s two-year rate is still about 6 basis points higher than the equivalent debt in the U.S., while Germany’s is about 95 basis points higher, Anderson said, adding that Canadian yields have largely kept pace with rising Treasury rates, which have continued to pull the Canadian dollar higher.
“The yield differential will provide upside for the Canadian dollar,” Anderson predicted. “It will help the Canadian dollar outperform the broader market.”
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