I’m torn about USD/CAD.
My base case if for a rally to 1.12 around mid-year but I won’t fight the technicals.
It’s time to take a step back and evaluate.
Some of the reasons for my expectations for a rally:
1) Interest rate differentials. The BOC has held rates at 1.00% since Sept. 2010. If any economic weakness materializes, a drop back to 0.25% is likely. The Fed, meanwhile, is already at zero and policymakers have set a high bar for QE3.
2) Commodity prices. It’s not shaping up to be a good year for commodities, especially if gold is excluded. Europe is headed toward recession, US construction is virtually nil and China’s growth is slowing. These factors may be priced in but I still see downside, especially with the risks from banks, brokerages and fund redemptions.
3) The threat of crisis. The longer the world remains at the edge of the abyss, the more likely it is that something pushes it over the edge. Europe, China, the US, the Middle East, Russia – each presents a multitude of risks in 2012.
4) US growth may see USD gains. We know that the USD will outperform CAD on safe haven trades but surprising US growth will not necessarily flow into commodities. If growth is driven by tech and the automotive sector, Canada may be left out.
5) There are risks in Canada. Housing prices in Canada have detached from reality. Several provinces are nearing budget crisis. Trade disputes are a risk. RIM is probably done.
But that is all old news. Here is some of what has me worried.
1) Oil. The tension in Iran is once again solidifying Canada as North America’s oil supplier. It is also driving up prices. With investment returns at nearly zero everywhere, some big money might flow into Alberta oilsands.
2) US stimulus. I often repeat: the US will never do austerity. Instead, more spending is likely on the way, with commodity-intensive infrastructure projects likely to benefit. At the same time, such projects will keep the US deficit high, removing any USD benefit.
3) A US bank failure (but not a crisis). After what happened at MF Global, it’s clear that nothing has changed. I wouldn’t be surprised to see a blowup at a major US financial this year. The surprise is that it will be quickly contained by the government (perhaps before the news even hits the market) and that would weigh more on USD, especially once talk of regulation re-ignites.
4) Growth. Canada historically lags US growth. If the US posts a strong first half, there will be a lag before the market appreciates that growth will spill over to Canada.
5) Mark Carney (BOC Gov). He seems to have a good sense of the risks facing Canada and has consistently fretted about housing. If the US starts to grow, he will beat the Fed on raising rates. If the US falters moderately, he may sacrifice rate cuts in order to control housing inflation.
I’m going to let it sink in for a few days but I’m on guard to sell soon, likely on a break of 1.0050.