Earlier this month, the US dollar looked like it might break out to a higher range against its Canadian counterpart but it's been reeled back in, in large part due to stubbornly high energy prices.
USD/CAD rose as high as 1.3077 on May 12 but didn't last long above 1.30 and has drifted back to 1.2787. Today, the pair is 30 pips lower as oil prices near $114 and natural gas trades up to $9.30.
Yesterday, US natural gas prices hit $9 for the first time since the fracking revolution took off in 2008, with Canadian benchmark prices close behind. Today, US inventory data showed a tighter market than expected, on high power generation demand in the US south, which has had a hot springtime. Inventories rose 80 bcf versus 89 bcf expected.
The loonie remains much lower than would be expected given high energy prices. A big reason for that is that permitting and pipelines have heavily constrained oil and gas investment in Canada. That could change due to security concerns after the Ukraine war and because of high prices and LNG demand. However it will be slow moving.
The poor risk sentiment since February has also boosted the US dollar broadly and hurt commodities currencies. This week after seven weeks of declines, the S&P 500 is rebounding. That's continued today with the index up 1.4%.
The major headwind for the loonie in the near-term will be housing. The Canadian housing market bubble has burst as mortgage rates rapidly rise.
My baseline is for a 20% decline but once things start falling, they can overshoot. This chart shows just how out-of-whack Canadian home prices are.
The second question is how hard a house price decline will hurt. A 20% decline really only erases a half-year of 2021 gains. For most, this was found money anyway. And since prices rose so quickly through the pandemic, very little of that was borrowed against or realized. There may be leveraged investors who get caught out though.
There will be direct effects though. Home transactions and real estate fees make up a surprisingly (and unsustainable) part of Canadian GDP. That will quickly come down.
A bigger problem could be mortage rates biting consumer spending. Canadians are nearly all on 5-year terms either fixed or variable, so rates hit everyone in time. On a $1m mortgage, a 2-3 percentage point increase in rates is a big bite out of disposable income.
Today's retail sales data undershot expectations.
The good news is that the downturn may come at the same time as a commodity-investment boom. That could help to cushion the fall in both the loonie and housing, at least in commodity-producing regions.
As for the loonie, I think we head lower (higher in USD/CAD) but with $114 oil and $9 gas, trade is a big CAD tailwind.
