Over the past week, in a relatively lackluster market, the Canadian Dollar (CAD) strengthened nearly 2%, the largest increase among the major currencies. There were a couple of reasons:
- The much stronger-than-expected Canadian labor market report last Friday was a major factor. Just prior to this, Canada saw the largest IQ GDP contraction since 2009 and many had thought that the Bank of Canada (BOC) would have to cut rates further. The new strong Canadian labor market report shows the market that is unlikely.
- The recent rebound in crude oil price has supported the loonie, (which is what Canadians call their currency) since 30% of Canadian export is oil. Saudi Arabia decided to stop oversupplying the market in March which has strengthened oil prices. The fall in crude oil inventory over the past week also supported oil prices, together with the CAD.
- The market chose to trade the CAD as a substitute trading currency to the USD. Incidentally, over the G7 meeting, President Obama mentioned that he saw the strong USD as “a problem” which led to a U.S. dollar (USD) contraction. The US had just reported a strong labor market report last week, and speculation mounted that the Fed may start raising rates as soon as September this year, so typically the USD should have strengthened. But instead of the USD, the market chose to buy the CAD.
Occasionally, the USD and CAD are deemed as sister currencies, as we share the same Northern American geography, similar economic frameworks and have strong trade ties. But whenever certain fundamentals favor the CAD, international investors use the CAD as the base currency, known as cross- trading. So instead of trading straight EUR/$ (selling EUR and buying USD), the market traded the EUR/CAD cross (sell EUR and buy CAD, instead of the USD) .
My View: Whenever markets trade cross positions more actively than straight USD positions it typically reflects the fact that they do not have a decisive view on the USD. Trading volume in CAD crosses are also smaller, resulting in more amplified price actions which partly explains the rapid CAD strength. While we still believe the USD will eventually strengthen, maybe the market is showing some signs of fatigue in maintaining their USD bullish position, given all the uncertainty surrounding global interest rates and geopolitical outlook.
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