The airwaves are filled with nonstop stories warning of global growth and an impending recession, but you wouldn’t do that with the Canadian dollar.
It’s one of the most growth-sensitive currencies in the world, but it’s also near the top of the global pack. It is second only to the US dollar this year among major currencies and just behind.
The reason for this is that the Canadian dollar is caught in the riptides. Fears of slowing global growth are justified and are weighing on the loonie, but it is being held back by other factors.
1) Canadian growth looks solid this year
Canada experienced a late exit from the pandemic. It took some growth from 2021 and pushed it to this year. The reopening of the Canadian economy has unleashed domestic demand even as global growth slows. These trends, however, could converge after a summer frenzy, leaving the loonie vulnerable in the fall as the market focuses on 2023.
With that, the Bank of Canada led the global rate hike cycle and those rate spreads are a big support for the loonie.
2) Raw materials vs everything else
There has been a real deterioration in global commodities and copper is at its lowest since February 2021, but energy is doing well. Even in commodities that have fallen, Canadian investments look more promising due to the war in Ukraine and Russia’s blacklist. A complete overhaul of LNG is also underway and this could add over $100 billion in direct investment in Canada over the next decade.
The problem is that if commodity prices continue to rise, everything else will fall. Central banks have engaged in a death match with inflation, which means that even if the next round of inflation is commodity-driven, they will tighten into a recession. This is a lose-lose and Canadian bulls would be wise to hope that oil and gas will stay at these levels rather than take another leg higher.
What happens next
We have been conditioned to view recessions as cataclysmic events. The last two were the financial crisis and the pandemic and these left lasting mental scars.
We’re probably heading for another recession, but it will be a mild recession confined to financial assets, something like the dot-com meltdown. The combination of easy money and leverage has inflated demand and driven growth. We’re going to trend back and it’s technically a recession but the labor market is going to hold up.
The pain will be concentrated in financial assets that relied on cheap money – tech stocks and real estate.
Fortunately, Canadian markets are largely trading at cheap valuations, but I have serious concerns about anything affecting the housing market. We will find out how isolated the banks are and where the skeletons are buried. The international market has yet to turn its attention to Canadian housing because there are heated discussions of overvalued housing everywhere, but the Canadian bubble is the real deal and it is bursting.
As for the USD/CAD, it will depend on the rate differentials. Think of it as a race against your big brother. The BOC can hold on to the Fed at around 3%, maybe 3.5%, but if big brother kicks into high gear and rises from there, the Bank of Canada can’t keep running, the real estate market is too vulnerable.
I think the real world growth and housing scare is still ahead and we’ll see 1.37-1.38 or 73 cents but I’m a bit more optimistic than a few weeks ago than inflation will moderate and that the truly negative Canadian and global results will be realized.
Europe is a disaster
Where investors absolutely must stay away is in Europe. Almost nothing good is happening in Europe on the economic front. If you were to ask all high-level politicians to write down their top 10 priorities, strong economic growth and the creation of a better business environment would be lucky to make the list. They are ready to sacrifice the economic health of millions – perhaps hundreds of millions – to punish Russia and build the United States of Europe. The green transition and carbon capture business will be huge, but Europe will also lose despite having a massive head start because it is top-down driven and polluted by ideology rather than technology. Solutions will come from America and Asia, as they have throughout the tech industry. This decade will be the final highlight of the idea of Europe as a source of global growth. The decline is terminal. The euro will reach parity with the US dollar shortly and with the Canadian dollar within a decade.