The Canadian dollar finished the week strong with USD/CAD falling to 1.2600 at Friday's close from as high as 1.2870 on Tuesday. That's very close to the seven-week low of 1.2587 set at the start of the month.
For months, the loonie has been stuck in a push-and-pull from rising commodity prices, sinking risk appetite and a broadly rising US dollar. The loonie is now almost right in the middle of the range it's carved out in the past nine months but factors are lining up for a break; with one big caveat.
Five things I'm watching:
1) Oil prices and the changing dynamic
The strength in the loonie mid-week was telling. It came even as oil prices fell from $109 to as low as $94.00. Crude later bounced to $105 but it was tough to see any correlation between crude and the loonie -- something that's been a decisive driver for CAD for decades.
Ultimately that connection will be reestablished. The price of oil will remain a key factor in Canada's terms of trade but in the bigger picture, investment capital is more of a Canadian dollar mover. The market is also discounting short-term oil price moves as commodity markets parse a fluid situation in Ukraine.
As the dust settles, what will be more important for the loonie is the investment landscape for Canadian oil and gas. I believe the war has been a game-changer for Canadian oil and gas along with its social licence. Policymakers globally are understanding the importance of secure supply from allies. I think some of the pie-in-the-sky optimism about a quick energy transition is fading as well. There's a growing realization that we will still need huge quantities of petrocarbons for decades and that it's better to get it from a place like Canada. I think that's particularly true with natural gas and this could reignite interest in west coast LNG projects.
As for a revival of Keystone XL? That ship has sailed but it might prove to be a recurring thorn in the back of Democrats and that's something that could shift the long-term conversation regarding Canadian oil in the US.
2) Carbon capture
Geopolitical instability will be a long-term positive for the loonie if it can spur is a positive for the loonie but in the short-term, watch out for Trudeau's emissions plan. It's been promised to be released this week or early next week with the budget. Canada's carbon capture success has gone under the radar but it's slated to be a gigantic industry and Canadian oil companies are all-in.
“Going after methane is a very good way to reduce emissions quickly, and there’s a lot of technology available,” Environment Minister Steven Guilbeault said recently.
The industry and government has done an awful job of selling it but there's an opportunity for Canada, led by its oil & gas companies, to develop carbon capture technology that can be deployed globally and ultimately reduce more emissions than every ton of carbon Canada produces.
I believe an investment boom in carbon capture is coming and how governments play their hand now will decide which countries win. Ultimately, that will be a trillion dollar industry. Timing when that boom comes is tough but the budget and investments in carbon capture will further that social license that Canadian oil and gas needs right now to attract larger investment into the space.
3) Other commodities
Like oil, there's a transition in thinking around the green transition. A few years ago, the thinking was that everyone would buy an EV, build some windmills and the world would be saved. There's been a reckoning about all the materials that will be required. The amount of metals needed is profound and Canada is one of the great mining countries. Canada has uranium and nuclear is back in vogue.
Beyond that, commodities in general are back. With the rout in tech, people are looking to invest in what's working and that's raw materials and that's Canada.
4) War in Ukraine
The war has compounded and highlighted trends that are already underway. Russia sells much of the same commodity mix as Canada so many of those investment dollars leaving Russia will eventually find their way into Canadian dollars.
It touches almost everything. I've highlighted energy and mining but the rallies in grains and lumber bode very well for Canada's terms of trade as well. Lumber has been left for dead for decades but US housing demand isn't going to slow materially for years.
In the short-term, what's restrained the loonie has been the volatility and fear around the war. That's normal but what's also normal is that the market gets a handle on risks very quickly. The initial shock of the war is fading and some lines have been drawn around energy and foreign interference that the market largely understands now. That can be shattered on a single headline but the market grows comfortable with risks quickly and we're already seen that start to unfold with the loonie's latest rally.
5) Covid
The emergence from covid is a wonderful tailwind for the domestic and global economy. Canada took a more-cautious approach than nearly everywhere but mask mandates in Ontario end on Monday and I'm relatively confident that widespread closures aren't coming back. With the weather getting better and consumers flush from stimulus and housing money, the Canadian consumer is going to surprise. I think that ultimately push the Bank of Canada towards an uncomfortably fast pace of hikes, starting with 50 basis points on April 13. That is a tailwind for the loonie.
The covid risk remains China. A jump to 5000 daily cases last week combined with lockdown measures in Shenzhen and Shanghai spooked global markets and ravaged Chinese markets.
Some of that was undone later in the week when China offered stimulus and said it would work to make it easier for businesses to operate around restrictions. What I fear is that could be a double-edged sword. Easing restrictions is good for right now but if China lets its guard down against omicron for a moment, it could very quickly turn into a situation like Hong Kong, where cases are utterly raging.
The Caveat: Housing
Canadians watch the housing market like it's Hockey Night in Canada.
Just in the last few weeks as rates have risen rapidly, there's been a shift. Homes that used to sell overnight are taking a week or two. Some of the statistics around the Canadian housing market remind me of Japan in 1988 when the land around the Imperial Palace was worth more than all of the real estate in California.
We're not at that level of madness but in 2021, investment in real estate exceeded all business investment in the country. The increase in home values exceeded all the combined wages in Canada. Houses made more money than people.
The party is over. It's a classic parabolic top after a long-term rise. With rates rising, the mania is coming to an end. When BOC Governor Tiff Macklem hikes rates 50 basis points in April that will be the unofficial end, though it's coming either way.
The question is whether it's a hard landing or a soft landing. The last 20% of the rise was all froth so I could see that evaporating. When that tide goes out we'll find out who is swimming naked. You'd hope the financial system has ringfenced such an obvious risk but the second round wealth effects are impossible to guard against. I've read the reports saying consumers will take it in stride but I would expect an anxious 3-9 month period that keeps a discount in the loonie, at least until housing finds a bottom.
The soft landing scenario would imply a flattening of prices. The best argument for that is that Canadians are largely fiscally prudent and relatively flush coming out of the pandemic. On top of that, we have 500,000 immigrants coming into the country a year and not nearly enough housing for everyone. It's tough to push prices down when demand exceeds supply.
We're just going to have to see how that plays out.