Remember back in May when all the hedge funds were short Canadian Dollars up the whazoo? At the time, I was worried the excessive pessimism might cause CAD to rally (Loonie Bears are the New Cool Kids). Well, since then, the Loonie has rallied 6.50% even in the face of a collapsing oil price and increased worries about the popping of the Canadian real estate bubble.
This morning the Bank of Canada hiked rates, the first time since their 2010 early attempt to normalize rates in the aftermath of the Great Financial Crisis.
The Loonie is streaking higher like a Canuck on a breakaway, and suddenly, all the Canadian Dollar bears are strangely silent.
Yet I am taking this opportunity to begin initiating a Canadian Dollar short position. Many of the concerns all those “cool” Canadian dollar bears voiced three months ago still exist.
The most obvious one is crude oil. As much as we would wish otherwise, our Canadian economy is still highly dependent on energy.
Crude oil has pushed down to new lows, while at the same time, the Canadian dollar has been doing the opposite and rallying hard.
But wait! Maybe the Loonie strength should be expected as Canadian rates are headed higher. Surely the Canadian dollar can’t just follow crude around tick for tick.
And yes, the other important determinant for Canadian dollar pricing is the relative interest rate differential between US and Canadian rates.
The spread between Canadian and US 2 year yields has been rocketing higher, which explains the Loonie’s action over the past few months. However the divergence between the interest rate differential and CAD seems to have closed.
Now that the Bank of Canada Governor Poloz has gotten the first hike under his belt, do you really think he will be more aggressive than the Federal Reserve? Or do you think he might take a “easy-as-she-goes” tact?
After all, don’t forget that the Canadian economy is dealing with a precariously perched highly real estate dependent economy.
What makes this even more amusing is that Poloz is raising rates in the face of weakening inflation. He is another Central Banker who views the decrease in inflation as “merely temporary.”
Although the Canadian dollar continues to rally hard this morning, I just don’t see how that much has changed. Sure Poloz is more hawkish, but to a large extent, his policy decisions will be driven by the Canadian economy’s performance. Given the high reliance on real estate, the last thing Canadian dollar bulls should be hoping for is higher rates. Both higher rates and a higher Loonie will sow the seed for its descent. Canadian real estate just became that much more expensive for overseas buyers, and the carrying costs for Canadian speculators has just become that little bit more onerous.
So all I can say to all those Canadian dollar bulls chasing it up here, sold to you.
Thanks for reading,