Fundamental Forecast for Canadian Dollar: Neutral

- April GDP unexpectedly flat
- USD/CAD channel signals further “loonie” losses

The Canadian dollar was one of the biggest losers on the week as the “loonie” declined nearly 300 pips against the greenback and 400 pips versus the yen. A dimming outlook for global and U.S. growth has started to cast a shadow on the export driven economy, which to this point has stood out for its stable banking sector and improving labor market. However, Canadian companies will be hard pressed to continue hiring if demand from abroad slows, as emerging markets thirst for raw materials have driven Canadian growth. The April GDP reading showed flat growth in April and signs that the manufacturing sector is slowing with activity contracting 0.3% which helped weigh the Canadian dollar.

Disappointing manufacturing and labor reports from the U.S. –Canada’s main trading partner- should add to the dimming interest rate expectations for Canada. Last month BoC Governor Carney stated that the prospect of renewed downturn in the world economy, and concerns about global imbalances and currency volatility, have increased downside risk to the stability of the Canadian financial system. The central bank became the first in the G-7 to raise rates last month which raised speculation that it was the first of several. The central bank leader squash yield expectations by stating that rates weren’t “preordained’ and that global factors would be considered in determining future policy. Despite policy makers concerns markets are still pricing in another 95 bps in tightening over the next year which could help limit downside risks for the Canadian dollar.

The upcoming economic calendar will go a long way toward shaping future yield expectations and “loonie” direction. Economists are forecasting that he manufacturing sector’s pace of expansion accelerated to 64.0 from 62.7 which would mark the sixth straight monthly improvement contradicting the GDP figures. May saw an improvement in the employment component, which could translate into additional hiring from Canadian employers. Indeed, the economy is forecasted to have added another 20,000 jobs in June with the unemployment rate remaining at 8.1% as the labor force continues to grow. This would be contradictory to the U.S. employment report which showed a shrinking labor pool and job losses of 125,000. Disappointment in either indicator could set the “loonie” for additional losses, but improving fundamentals may restore the Canadian unit’s attractiveness.

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