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   By Guest Blogger Ryan Lewenza

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The US dollar has been given the moniker ‘king dollar’ as it is the world’s reserve currency that powers much of the global economy. That nickname definitely rings true for this year with the US dollar up against every major currency around the world.

Below is a chart showing the US dollar appreciation versus all the major global currencies for this year. For example, the US dollar us up 1.6% versus the British Pound and up 10% versus the Japanese Yen. Driving the Yankee dollar higher is the sticky US inflation, which is causing the Federal Reserve (Fed) to push out the expected rate cuts for this year.

In the beginning of the year the bond market was pricing in six rate cuts (we said this was a pipe dream), and now the bond market is pricing in just a few cuts later this year as US inflation has remained well above the Fed’s 2% inflation target.

The prospect of higher US interest rates, and concerns around our out-of-control government spending and deficits, have weighed on our Canadian dollar with the loonie down 3.4% this year. With the recent weakness in our dollar, it’s brought out some bears with one highly regarded portfolio manager making a bold prediction that the loonie could fall to 50 cents in the coming years if things don’t change.

Yes, the near-term outlook for the Canadian dollar looks challenging but I don’t see our dollar declining any where near 50 cents and, in fact, see the potential for the Canadian dollar to rebound over the next 12-18 months.

Global currencies y-t-d performance vs the USD

Source: The New York Times

Some years back when I was the Chief Strategist for Raymond James, I did an exhaustive study trying to determine the main drivers of the Canadian dollar. I compared the Canadian the dollar to a number of different economic and market indicators and found that the two main indicators/drivers of the CAD/USD are: 1) commodity and oil prices, and 2) the interest rate differential between Canadian and US bonds.

Let’s examine these two drivers to see what they could portend for the Canadian dollar in the coming months.

First, commodity and oil prices have been doing quite well this year, which is generally bullish for our dollar. For example, US oil prices (WTI) are up 10% so far this year, while copper prices have been on a tear, up over 15%.

As seen below, the CAD/USD dollar tends to track oil prices pretty closely over time. Going back all the way to 1994, there has been a 0.80 correlation between the CAD/USD and oil prices, so oil/commodity prices do play a role in our dollar. More recently, we’ve seen this correlation decline so the current high oil prices are not having as much of an impact on our loonie.

These correlations are not static or fixed. They change over time as we’re seeing right now, but I continue to believe oil and commodity prices will remain important drivers of our loonie over the long run. And, given I’m bullish on commodity prices over the next few years this should help our dollar, and we could see our dollar rebound over the next year.

Canadian dollar and oil prices

Source: Bloomberg, Turner Investments

Second, the spread or interest rate differential between Canadian and US bond yields are an important driver of the CAD/USD and right now, this is negative for our loonie. It looks all but certain that the Bank of Canada (BoC) will cut interest rates in the coming months. Our economy has stalled out, inflation in Canada has slowed more than in the US, and there is an estimated 80% of all outstanding mortgages as of March 2022 that are coming up for renewal in 2024. I believe these factors will push the BoC to begin cutting interest rates this year, potentially as early as their June meeting.

In contrast, the US economy is performing much better, inflation is running hotter in the US and given that US mortgages are much longer in length (30 years), I don’t see the Fed in such a rush to cut interest rates. More likely we’re looking at cuts later this year.

If the BoC begins cutting rates before the Fed, Canadian bond yields will decline relative to US bond yields, and this would be negative for our Canadian dollar. I illustrate this in the chart below. The chart overlays the CAD/USD currency with the difference in 2-year interest rates between Canadian and US government bonds. Essentially, when interest rates are higher in the US than in Canada, as is the case at present, then this tends to be negative for our dollar and a big reason why the Canadian dollar has dropped this year.

CAD/USD rate with CAD/USD interest rate differential

Source: Bloomberg, Turner Investments

So, we have two main drivers for the Canadian dollar with one negative (interest rates) and one positive (commodity prices). Currently, the CAD/USD sits around 73 cents and it could drop a few more pennies if/when the BoC starts to cut rates. Maybe it bottoms out in the low 70s this year. But, given my positive outlook for oil and commodity prices, and that the Fed will cut rates inevitably, the Canadian dollar could rebound later this year and into 2025.

I wrote a blog on the loonie a few years back and predicted the CAD/USD would trade rangebound between roughly 70 and 80 cents, and this forecast has proved to be accurate. I continue to hold this view and therefore recommend investors trim their US dollar holdings when the CAD is in the low 70s and buy US dollars with CAD when the CAD is high around the 80s level.

Here at Turner Investments we’re watching the loonie closely and we may look to reduce (sell) some of our US dollar exposure if it dips into the low 70s as I don’t see it getting much below this level and definitely not falling all the way down to 50 cents.

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Investment Advisor, Private Client Group, of Raymond James Ltd.

Regular addicts will recall what used to happen here. For years macroeconomists in the steerage section argued interest rates could not rise. Impossible. The government would never allow it. There’d be a crisis. Families would collapse. Real estate would rot.

Well, up she went. Ten times.

Now read current comments. Yesterday was a fine example. The same experts tell us rates can’t fall. Impossible. Inflation will explode. The currency will crumble. Houses will cost three million. The debt crisis will eat us.

And they’ll be wrong again.

Friday morning we learned US employers put the brakes on hiring. Payroll gains that have averaged almost 270,000 a month dropped to 175,000. The unemployment rate went up. Wage gains went down. Mr. Market immediately raised the odds of a Fed rate cut in September to 50%. Said an actual economist: “For those looking for a rate cut sooner than later, this deceleration in payroll growth is good news, and the weaker wage growth number makes it even better news.”

Well, it’s only one report. Lots more data to come. But the inevitable will occur. As my pal Doug wrote here last weekend, there’s a pattern of multiple rate cuts after a tightening cycle. And we will soon see them triggered now that CB boss Jerome Powell confirmed increases are over. Kaput. Done like dinner.

Also a consensus view is that Canada will cut first. Yesterday we gave you the odds for June: 66%. If not then, circle July 24th. But it will happen.

Now, what’s the impact of all this rate dithering and debate on real estate?

The major markets have reported. Calgary continues to be on its own planet (we’ll call it ‘Danielle’) with locals merrily driving prices higher. Sales are up 7% y/y, prices have romped 10% and new listings just popped 11% (while active listings are down 16%, thanks to the rush of buyers). Higher rates have done zip to stop the hormones.

In the rest of the country, it seems buyers are (a) priced out and suicidal or (b) waiting for rates to drop so they can pay more.

In the mighty GTA, head realtor wizard Jennifer Pearce gives this explanation for a moribund market: “While sales are expected to pick up, many would-be home buyers are likely waiting for the Bank of Canada to actually begin cutting its policy rate before purchasing a home.” And real estate board analyst Jason Mercer is warning of higher prices to come, once that occurs: “Looking forward, the expectation is that lower borrowing costs will prompt tighter market conditions in the months to come, which will result in renewed price growth, especially as we move into 2025.”

Despite the fact it’s prime rutting season, sales dropped 7% y/y. Only 750 detached homes changed hands in all of 416. Ugly. The overall price of properties barely budged and listings bloated. Up 47% for the month and a meaningful 74% advance over last Spring.

The average Toronto detached is $1.8 million – $200,000 off its record, and equally below where Vancouver singles now sit. In that city sales are marginally higher and active listings have hit a four-year high, up 64% y/y.

Says the Van cartel: “The surprise for many market watchers has been the continued strength of demand along with the fact few homeowners have been forced to sell in the face of the highest borrowing costs experienced in over a decade.”

In short, the Bank of Canada generally managed to dampen the housing market, but has done nothing to restore affordability. (That’s actually not its job.) Now as mortgage rates decline (TD just brought in a sizzling 6.1% VRM), inventory is stacking up and buyers are expected to flood in. That’s what Canadians do, of course. When the market is cold, sellers desperate and bargains abound, we stay home. When conditions are steamy and competition driving prices higher, we get FOMO. Never fails.

In summary, rates will go down. Slowly. Pandemic mortgages at sub-2% ain’t coming back. Recession is unlikely. Housing is not going to collapse (if ten rate hikes didn’t do it, nothing will). The rest of 2024 will be volatile and often scary (Trump). The Leafs will lose. And some predictions are easier than others.

About the picture: “Bella-rosa is growing up,” writes Kathryn. “She is 7 months old on May 7. We shared her on your blog when she was about 2 months old, just a little one then. She is quite the young lady now, one with a mind of her own to be sure. Thanks for your wonderful posts, Garth. I always look forward to them.”

To be in touch or send a picture of your beast, email to ‘[email protected]’.