The fact that the loonie rallied a further 0.4 per cent on Friday while oil prices slid 2.3 per cent provided a clear sign that the Canadian dollar is responding more to expectations of additional Bank of Canada rate hikes at the time when the U.S. Federal Reserve has suddenly turned a bit more dovish. While the Fed has good reason to be less strident on its growth and inflation view, the same could be said for the BoC.
Since the lows in May, the loonie's surge has been equivalent to nearly 300 basis points of policy tightening. The power of the currency's ongoing run-up since July 12 has been nearly double that of the actual rate increase that day. Exporters and tourist operators are no longer dancing in the streets. The tightening in monetary conditions has been significant and Stephen Poloz, who once headed Export Development Canada, may well start to downplay the need for additional rate hikes, in order to curb the loonie's dramatic rally.
The Canadian dollar has pretty well mean-reverted as it approaches 80 cents (U.S.). And while an overshoot may be likely, the support from any further short-covering has fully abated as the latest CFTC data show a net speculative long position of 9,848 contracts on the Chicago Mercantile Exchange, the first time since mid-March that the collective bet was bullish on the loonie. We are not far off either the level of the CAD or the level of the net longs that snuffed out the comparable rally off the oversold lows in the spring of 2016.
It should also not be lost on anyone that at the time of the BoC rate hike and hawkish guidance, Mr. Poloz et al. likely had no clue that the Fed was about to pivot the other way. And let's face it, the common core rate of inflation at 1.4 per cent is nowhere near the Bank's target. And the headline rate in June melted to 1 per cent from 1.3 per cent in May (consensus was looking for 1.1 per cent). While the 0.6 per cent month-over-month jump in May retail sales looked good, there was nothing happening at the ex-auto level. Tack on the completely changed housing landscape in the Greater Toronto Area, and the Bank is likely to follow in Janet Yellen's footsteps and back away a bit from the rate-hiking threat (at least for the next several months).
David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.