Weakening Trend Likely Ready To Resume For Canadian Dollar

Includes: FXC
by: Dr. Duru

On April 17th, the Bank of Canada decided to leave interest rates unchanged. In its Monetary Policy Report Summary, the Bank of Canada extended its forecast to mid-2015 as the time when the Canadian economy will finally return to full capacity:

On a quarterly basis, growth in Canada is expected to pick up to about 2.5 per cent in the second half of this year. Despite this expected pickup, with the weak growth in the second half of 2012, annual average growth is now projected to be 1.5 per cent in 2013. The economy is then projected to grow by 2.8 per cent in 2014 and 2.7 per cent in 2015, reaching full capacity in mid-2015 - later than anticipated in January.

With expectations for inflation to only gradually rise to 2% by mid-2015, I am assuming the Bank of Canada is very likely to leave rates low until then. This target is no accident. This is also the year that primary dealers expect the federal funds rate to FIRST increase. According to the Minutes of the Federal Open Market Committee on March 19-20, 2013:

Results from the Desk's survey of primary dealers conducted prior to the March meeting showed that dealers continued to view the third quarter of 2015 as the most likely time of the first increase in the target federal funds rate. In addition, the median dealer continued to see the first quarter of 2014 as the most probable time for the Federal Reserve's asset purchases to end, and most dealers anticipated that the pace of purchases would be adjusted down before ending.

Moreover, the Federal Reserve staff continue to project subdued inflation through 2015.

The Bank of Canada's projections of a marginal decrease in the GDP growth rate from 2014 to 2015 are less optimistic than the marginal increase it expects for the U.S. of 3.1% to 3.3%. (For comparison, the Federal Reserve staff expect a range of 2.9 to 3.4% in 2014 and 2.9 to 3.7% in 2015). In other words, the Canadian economy should continue to follow the U.S. economy yet slightly underperform.

For added emphasis, here is a chart from the St. Louis Federal Reserve showing the close correlation between Canadian and U.S. annual GDP growth rates:

Canada Vs U.S. Real GDP Annual Growth Rates Since 1961

Source: Federal Reserve Bank of St. Louis (NASDAQ:FRED)

A big part of Canada's problem is the very slow recovery in exports. The Bank of Canada blames "…restrained foreign demand and ongoing competitiveness challenges, including the persistent strength of the Canadian dollar" (emphasis mine). As I demonstrated in "A Weakening Canadian Economy Needs A Weaker Currency", Canada's export growth came to a screeching halt after the year 2000 when the Canadian dollar (NYSEARCA:FXC) began a rapid trend of strengthening against the U.S. dollar. So with the Bank of Canada stretching out its "full recovery" target to mid-2015, it is no surprise that the Canadian dollar weakened (slightly) after the statement on monetary policy. USD/CAD is now above its 50-day moving average (DMA) again and looks set to resume the upward move from the lows of September, 2013.

The U.S. dollar looks ready to resume its strength against the Canadian dollar

Source: FreeStockCharts.com

Since the abatement of the 2008-2009 financial crisis, USD/CAD has traded in a relatively well-defined range. The currency pair is now in the middle of that range. Absent any dramatic changes in economic conditions or trends, I continue to expect a gradual return to the top of the range (around 1.08), and I will not be surprised to see USD/CAD continue to move higher in the many months to come if the actual economic numbers show on-going out-performance by the American economy over the Canadian economy.

Be careful out there!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: In forex, I am long USD/CAD.