Deutsche – FX Daily : Curb your enthusiasm for CAD: FXWW

From the FXWW Chatroom: Since we took profit on USDCAD longs in early March, the Canadian dollar has enjoyed a solid recovery (+3.3%), although further progress in this direction may now become more difficult.

Firstly, regarding today’s BoC meeting, we believe the policy stance is likely to remain cautious in light of growing evidence of housing troubles. We now see a deterioration in national new home prices, with March data being the first monthly decline since 2010. This complements the third consecutive monthly decline in existing home average sales prices, 1. Residential home sales in the first quarter are down -11% compared against the 2017 full year, and down -15% yoy.

Second, although employment growth registered a positive surprise this month, and earnings growth as reported through the Labor Force Survey (LFS) has been consistently above +3% yoy as of January, this may not yet register as a warning sign for BoC. Rather than rely on any one signal, the BOC prefers the less volatile wage-common measure which is statistically derived from LFS and other sources to identify commonalities amongst disparate measures. In fact, the wage-common relies least upon LFS and much more upon National Accounts and Productivity Accounts. Given the delayed nature of these reports we suspect that Poloz’s assessment of untapped potential in the economy may not yet have changed materially. Also, recent readings of (youth) labor force participation pegged near the 2016 low suggests labor market slack remains a worry keeping Poloz ‘awake at night’, 3.

Combined with the weakness in the housing market and the relatively high indebtedness of the Canadian consumer, 2, these continuing concerns are a key factor why we expect the BoC to lag further behind Fed hikes this year than the market currently prices. Moreover, even at the current 1y1y OIS spread of roughly 0 bps, USDCAD looks 4% too low, 4.

The external backdrop has boosted CAD of late, but may not have much further to contribute near term. For one, the currency has likely been helped by encouraging noises from NAFTA talks although negotiating positions may remain some distance apart. US Vice President Mike Pence and Canadian Prime Minister Justin Trudeau have suggested that an agreement may be only weeks away. Having already priced out much of the negative NAFTA concerns for Canadian trade, a successful conclusion to the ‘permanent’ round of talks underway may be underwhelming from a currency perspective.

Additionally, oil prices may have little fuel left to drive further weakness in USDCAD. First, global markets are factoring in a larger geopolitical risk premium, but there are limits to this given the lack of immediate risks to supply from the Syrian civil war. The most proximate risk lies with the Iranian nuclear deal, and here, there are equal chances of a supplemental agreement becoming the preferred solution given the reluctance of European partners to scrap the deal. With WTI being near our medium term expectations we do not see oil prices pointing to much further downside in USDCAD. Second, the WCS spread has tightened towards USD -15/bbl from USD -30/bbl. Assuming a crude oil quality discount of USD 8/bbl and USD 5-7/bbl pipeline transport cost, there are limits to how much tighter this spread can go, 5.

While we remain medium-term constructive, we are tactically neutral for the time being as USDCAD looks for a bottom near these levels.

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