***Below is a recent institutional research note written by Hedgeye Senior Macro analyst Darius Dale
Recently, Keith added the Canadian dollar (FXC) as a long position to Investing Ideas, citing our GIP Model’s projection for the Canadian economy to remain in #Quad2 here in 1H17E. On the growth front, driving the model’s expectation for accelerating Real GDP growth here in Q1 and again in Q2 is a confluence of receding base effects and trending momentum in high-frequency data and/or breakouts in key leading survey readings.
Specifically, the bullish breakout in Canadian Consumer Confidence here in FEB implies the nascent breakout in Retail Sales growth is likely to develop into trending strength.
Moreover, the bullish breakout seen in both Canada’s Manufacturing PMI (JAN) and Business Confidence (DEC) would seem to suggest the trending strength in Canadian Export growth is likely continue and that Industrial Production growth should follow suit in the coming months.
On the inflation front, the confluence of transitory knock-on price effects from cycling through the lows of the crude oil price cycle and elevated PPI readings should perpetuate higher CPI readings on a short lag.
What’s interesting about the Loonie here in particular is that it has shown a considerable amount of strength in recent months despite Canadian rates markets not having priced in much of the aforementioned economic factors.
Specifically, the CAD is up +3.3% over the past 2M in the face of 1Y OIS Spreads and 2Y Sovereign Debt Yields down -3bps over that time frame to 3bps and 0.76%, respectively; 10Y Sovereign Debt Yields have declined -13bps over that same duration.
That 10Y CAD Breakeven Rates have advanced +5bps in that time frame is supportive of our #Quad2 expectation and our belief that much of what’s weighed on CAD interest rates over the past ~2M are pressures emanating from global sovereign debt markets (e.g. UST 10Y Yield down -14bps).
Moreover, President Trump talking down the U.S. dollar has provided a nice bullish handoff for the CAD to begin pricing in its own #Quad2 reality over the intermediate term and we anticipate further (and investable) upside with respect to the intermediate-term TREND.
In terms of highlighting key risks, Prime Minster Trudeau’s leftist agenda and Canada’s Current Account Deficit remain as structural headwinds to the CAD, so we’ll likely need to see crude oil gap up another leg higher to see outsized gains (i.e. > 15-20%).
