It seems as if it was only yesterday that the Canadian dollar was hitting 12-year highs against the US dollar on prospects of more interest rate hikes, rising oil prices and a tight labor market. Since then the tables have turned and the Loonie has given back 600 pips of those gains against the greenback over the past 6 months. Growth has gradually improved since September of 2004 and the recent rally in oil prices has given the CAD renewed strength.
Politics Weighed On Loonie in First Half - One Deciding Vote Secures Martin's Post
After a tense and extremely close federal budget vote, Canada 's Prime Minister, Paul Martin and his Liberal Party have managed to escape new elections and retain their political positions until at least early 2006. The vote, which took place on May 19 th , was more than just a routine budgetary ballot; it paralleled as a vote of no confidence, with Martin stating that if his budget did not pass, he would call early elections and step down from his position as Prime Minister. The political turmoil has been raging in Canada for months due to the surfacing of a government advertising scandal in Quebec . Although the loitering of funds took place while the former administration was in power, it occurred under the watch of a Liberal government. Furthermore, Martin was serving as finance minister at the time.
The vote itself was extraordinarily close, with the Liberals winning by one vote in the House of Commons. Moreover, the victory only occurred because generous concessions were granted and unrelated political cards played to defeat members of opposing parties. The support of former conservative leader, Belinda Stronach was especially important for Martin's victory, along with a few key independent voters. The leftist New Democratic party was also a large part of the Liberal's victory. However, with their support came compromises in the form of greater government spending. This could be a source of trouble in the future as the increased funding of education and environmental related projects has the potential to threaten the balanced budget and is already drawing huge amounts of criticism from the Conservative Party and the Bloc Quebecois.
Martin might have been able to get his budget passed, but that does not mean his political drama is ending any time soon. Analysts speculate that this ordeal is far from over. The Canadian government remains exceedingly fragmented; an atmosphere that will not be conducive to effective governing. Along with this, Conservative and Bloc Québécois leaders, seeing a very vulnerable party in power, are stepping up their efforts for the 2006 elections. This ongoing tumultuous political situation has left investors wary. Even after the incumbent government has managed to ward off their adversaries, their position is far from secure and their opponents feel far from defeated.
But Reverse Course In Oil Prices Spur Optimism
Being the ninth largest producer of crude oil in the world, Canada 's currency has a strong positive correlation with oil prices. In fact, over the past year, the weekly correlation has been close to 70%. This means that if oil prices rally, the Canadian dollar also has a high likelihood of rallying. The renewed strength in oil and the break above $60 a barrel has proved to be very positive for the CAD. If oil prices continue to rally, the loonie should do so as well. However at some point, the benefits begin to subside as higher oil prices will take a significant toll on US consumer spending. The US is Canada 's largest trading partner and weaker growth and spending in the US will certainly also be felt up North.
China
Yet all hope is not lost. China is Canada 's second largest trade partner next to the United States . Between 2003 and 2004, exports to China increased 38.6%, with the world's most populated country growing by 9.5% in the first quarter of 2005. There are no signs that the Asian giant is slowing. This is even truer in regards to China 's demand for commodities. China is just beginning to embark on its path of modernization. Even though they have a population of 1.3 billion people, 4 times more than the US , their consumption of core commodities are still relatively smaller than their more industrialized peers. As the country continues to grow and increase productivity, its demand for commodities is expected to increase as well. This long-term source of demand will continue to support the industries of heavy commodity exporters such as Canada , which will keep USDCAD gains limited.
Technical Outlook
Early 2005 proved to be a turning point for many currencies including the Canadian dollar, which hit a 12-year high against the US dollar during the end of last year. The previous six months have seen the pair climb toward the 1.3000 figure, but fail to break above the trendline that dominated the price action since late 2002. As a result, the price action for the next six months will most likely consist of range trading with a clearly marked top and bottom at 1.1700 and 1.2800. As the price continues to fluctuate within an ever tightening range, the last quarter of the year will most likely see the pair stage a breakout above the 1.3000 figure.
Indicators signal range-trading conditions with Stochastic dipping below the overbought line at 74.38. ATR is in the mid-range with the weekly range exceeding 200-pips. ADX (DMI) added to the range trading outlook with DI+ and DI- continually crossing each other, thus constantly issuing buy and sell signals, which is indicative of range trading.