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November 6, 2007
Should Canadians Go Global?
To note: While economists at the Bank of Nova Scotia, Royal Bank, BMO, and CIBC have spent the last week raising their outlook for the loonie and speculating about $1.10 and $1.12, bear in mind that many negative notes on the loonie have arrived in the short time since this commentary was released.
Globe & Mail: “The Canadian dollar vaulted over the $1.08 (U.S.) mark to a record on Tuesday, prompting a chorus of analysts to declare the currency is overextended.”
Canada Dollar Too Strong, JPMorgan, Lehman, Morgan Say BL
At the beginning of 2007 the consensus held that the Canadian dollar, the loonie, was at risk of weakening versus the U.S. dollar. After a terrific rally in the loonie in recent years, this outlook was based upon basic contrarian speculations, not to mention the expectation that a weakening U.S. economy would materially and negatively impact the Canadian economy. For anyone who has watched previous North American boom/bust cycles unfold the connection between the U.S. and Canadian economy is well known (i.e. while there may be a lag the Canadian economy tends to follow the U.S. economy). As Scotia recently reminded us, the ties between the U.S. and Canada run deep:
“Canada has the highest export exposure to the United States of any country, with US-destined goods shipments accounting for almost 30% of national output.” Scotia FX Outlook PDF
But as the U.S. housing market has gone into recession and analysts have lowered their expectation for U.S. growth, the outlook for the Canadian economy has not dimmed. Rather, Canada’s increasingly commodity focused economy is growing strongly and generally expected to continue to do so, the Canadian jobs market is surprisingly strong, and the deep sense of woe surrounding the U.S. housing market has not been mirrored in Canada. Not surprisingly, these trends - not to mention the increasingly negative sentiment surrounding the U.S. dollar - have been super-bullish for the loonie.
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There will come a time when Canadian investors would be wise to increasingly put their hot currency to work on the global stage. Moreover, dare I say it, there may even come a time when it becomes opportune for Canadians to shift assets away from loonies and into greenbacks.
This outlook isn’t necessarily based upon an imminent call for weakening commodity prices to strike the loonie back below parity, but on the conclusion that as more speculators attach themselves to recent gains in the loonie there could come a point when investor’ tunnel vision turns a blind eye to loonie/commodity fundamentals. For example, as per a very simplistic look at the recent rally in the loonie versus crude oil, you could start to build the case that strength in the loonie has already nullified recent strength in crude oil.
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Canadian investors may do well to remember that while clearly more resilient, the Canadian economy is unlikely to prove impervious to a U.S. recession. With many analysts now calling for the loonie to appreciate above the $1.10 USD. level, the contarian currency spirits present as 2007 began have vanished, perhaps just as they should be starting to stir...
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