The loonie is on a tear that has seen it gain six cents since bottoming out at just above 68 US cents in March, but some analysts are warning the currency’s rise is likely unsustainable and are anticipating another sell-off. A combination of the global economic shutdown and declining crude prices in the wake of an oil price war launched by Saudi Arabia sent the Canadian dollar plunging from about 75 US cents in early March to as low as 68.18 US cents, its lowest level since 2016. But much like the equity markets, that trend eventually reversed itself, particularly over the month of May when the loonie gained four cents.

Canada, also reported surprisingly strong jobs data at the end of May and is a major producer of commodities, including oil, so the loonie tends to benefit from a brighter outlook for the global economy. On top of that, Canadian housing starts rose to a seasonally adjusted annual rate of 193,453 units in May from 166,477 units in April, according to the Canadian Mortgage and Housing Corporation.

Sun Life Global Investments chief investment officer Sadiq Adatia said the recent reversal in the value of the loonie is more strongly associated with the U.S. dollar’s weakening position. Investors flocked to the greenback in search of a safe haven during March, he said, and as equity markets continue to roar, they’re slowly beginning to take on more risk again. That includes investing in other countries, Adatia said.

“We’ve seen money start to flow out of the U.S. dollar and back into other currencies as risk-on trade starts to come back a bit and you see markets rebound,” Adatia said. “On top of that, our currency is still a commodity currency — it got the benefit that we’re starting to see oil prices rebound.”

The loonie’s move is coming amid a hint of a rotation in the U.S. equity markets, Adatia said. The past weeks have seen stocks in the more beaten down sectors such as airlines, retail, restaurants and energy begin to rally while technology is on a less torrid pace. Adatia thinks this is particularly true when it comes to the new money entering the market.

Canada is a sound target for that strategy. Outside of Shopify Inc., there are few technology companies in the country that would draw the eyes of an international investor. What the TSX is ripe with are companies in the energy and financials sectors, both of which have benefitted in the past weeks from that early rotation Adatia described.

The loonie’s rally to the greenback has actually led performance in G10, according to TD Securities senior FX strategist Mazen Issa. Like Adatia, Issa attributes the recent move to the capitulation of the U.S. dollar. Rising oil prices have helped, although the link between the currency and crude prices may not be as sensitive as people think. 

And in the last two cents of this rally, from 72 to 74, Issa spotted a short squeeze. “Basically, it’s been the perfect storm,” said Issa, who also added there has been an increase in inflows to Canadian fixed income. “In the grand scheme of things, CAD is a price taker and is getting pulled along for the ride in risk assets.”

That’s likely why the rally isn’t meant to last. The loonie’s current levels should encourage caution, he said, because a lot of the good news in relation to the recovery from COVID-19 is already built in. The momentum of the rally could take it to 75 cents before the expected drawdown hits, reverts investor attention back to the U.S. dollar and sees the Canadian currency dragged back to 72 cents.

Adatia, who said the economy is heading for a W-shaped recovery, sees a similar fate for the loonie. There are too many macro factors, particularly when it comes to consumer demand and unemployment, working against it to allow the currency to sustain its current levels in the long-term. “There’s a little too much optimism at the moment,” said Adatia. “As we get back to reality of where hard-line earnings are and where consumer demand is, we’ll get that leg down and money will flow back to the U.S. dollar.”

Source:  Financial Post
Source:  Globe and Mail