By Ketki Saxena
Investing.com – The Canadian dollar ended the 2023 trading year within pennies of its opening bids for the year, kicking off 2023 near 1.3550 and spending most of the year range bound between 1.3000 and 1.3900.
For much of the year, the Canadian dollar fluctuated in tandem with volatile crude oil prices, and came under pressure from the Bank of Canada, which has kept rates on hold since July as the Canadian economy contracts.
For 2024, analysts the BoC vs. Federal Reserve rate differential, a continued correlation with crude, and economic headwinds to be the key drivers for the loonie.
USD/CAD Drivers in 2024?
Economic Slowdown in Canada and Globally
"The Canadian dollar is going to face a difficult next three months as the data starts to look like the Canadian economy is teetering on the edge of recession if not in a mild recession"
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Simon Harvey, head of FX analysis for Monex Europe and Monex Canada.
The Canadian economy, which has only narrowly avoided two consecutive quarters of is expected to further contract through 2024.
Latest data from Statistics Canada last Friday showed that the Canadian economy was flat in October, while September's GDP was downwardly revised to zero growth. Meanwhile, the US economic growth remains relatively robust.
The Canadian jobless rate also continued to climb in 2023, closing in on 6% in November. rate continued to climb through 2023, approaching 6% at November’s print. The US employment rate meanwhile is around 3.6%
The US and Canada have both seen household debt as a ratio of GDP fall steadily in the past two years, but Canadian households remain exposed to economic downturn with consumer debt still measuring 103% of Canada’s GDP, compared to the US’ rate of private debt to GDP sinking below 74% in the second quarter of 2023.
Of course, one of the key implications of economic slowdown in Canada vs. relatively robustness in the US is the expectation and likelihood the Bank of Canada will cut rates faster and more aggressively than the Fed.
Diverging Central bank policy
“Looking ahead, we don't see much support for the CAD given our forecast for a slowing global economy and the potential for more aggressive interest rate cuts in Canada relative to the US due to weaker domestic demand.”
In 2023, the BoC and Fed moved more or less in lockstep, with both central banks reaching what is widely seen as their terminal rate in Q3. The BoC and Fed are ending 2023 with their benchmark rates at 5.0% and 5.5%, respectively.
In 2024 however, markets anticipate a policy diversion, as the economies of the US and Canada take on different trajectories.
As the Canadian economy weakens, money markets see a roughly 25% chance of a rate cut from the BoC as early as January, and a 50% chance of a cut in March. A rate cut is fully priced in for April.
These expectations have been largely reinforced by BoC policymakers, including Governor Tiff Macklem. Earlier in December, Macklem noted that “This tightening of monetary policy is working, and interest rates may now be restrictive enough to get us back to price stability”.
He also noted that “The excess demand in the economy that made it too easy to raise prices is now gone.”
When it comes to the Fed, markets anticipate rate cuts as early in March. However, commentary from Fed policymakers have provided little credence to these expectations.
Crude Correlation
“The correlation between the Canadian Dollar and Crude Oil is likely to hold firm through the upcoming trading year…. Despite musings in recent years about a shakeout in the Loonie-Crude connection"
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Joshua Gibson, FX Street
While the Canadian dollar saw a modest decoupling from crude prices in H2 2023, with the loonie rising despite crude oil weakness, the historic correlation between crude prices and the Canadian dollar is expected to be a key driver in 2024.
The loonie typically benefits from higher crude prices in two ways: by boosting Canada’s trade and current account balance, and through a net positive impact on the Canadian economy due to increased business investment from oil companies.
Next year, headwinds for crude demand are expected to put a damper on the Canadian currency as the Canadian economy, and global growth slows.
An alternative, but “not very imaginative forecast” for the USD/CAD
“The biggest drivers of USD/CAD will probably be the general direction of the USD (which we expect to be weaker as US growth slows) and the relative shifts in Canadian and US longer-dated bond yields.”
Analysts at ANZ are amongst those who expect the loonie to strengthen vs. the US Dollar in 2024, as the USD weakens and US yields fall, under the assumption that the BoC and Fed will ease monetary policy in lockstep.
They note that, “A falling US yield environment and a weakening Dollar should drag USD/CAD lower in the absence of fresh new idiosyncratic drivers of the CAD.”
Analyst Expectations for USD/CAD
The median survey of 35 foreign exchange surveyed by Bloomberg shows that analysts expect the loonie to strengthen moderately vs. the US dollar over the next three months.
Analysts surveyed in the Dec. 1-5 poll expected the loonie to strengthen 0.4% to 1.3533 per U.S. dollar, or 73.89 U.S. cents, in three months, compared with 1.3450 in a November poll.
It was then expected to advance to 1.3130 in a year, versus 1.3000 in November’s forecast.
Bearish Bets on Loonie at Nearly Five Time high
“The Canadian dollar short base is still substantial as inflation remains stubborn and growth lackluster”
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Brad Bechtel, global head of foreign exchange at Jefferies LLC in New York
Speculators meanwhile have boosted their bearish bets on the Canadian dollar to the highest in nearly five years, as per the Commodity Futures Trading Commission.
As per the data, leveraged funds boosted their wager against the loonie to 51,971 contracts in the week ended Dec. 19, the highest since January 2019. ‘