The Canadian Dollar Came Under Pressure on Tuesday after the Release of First Quarter Canadian Growth Figures Undershot Expectations
The growth rate in Q1 rose 2.4%, which though higher than Q1 in 2015 was nevertheless below estimates of 2.8%.
The GDP growth rate in March was 1.1% which was slower than the 1.4% expected and the 1.4% of the previous year's March, which itself was a downwards revision.
On a monthly basis the economy was shown to have shrunk by a faster-than-expected -0.2% from -0.1% previously and deeper than the -0.1% forecast.
NBF Economics, a subsidiary of National Bank of Canada, commented that:
"Canada’s GDP growth was weaker than expected in the first quarter of 2016, with the disappointment compounded by downgrades to last year’s results."
NBF questioned the sustainability of the positive growth areas cited in the report such as Consumption and Residential Investment, as the former was due to a reduction in savings rates and not increased income, and the latter was probably not sustainable.
"Other pieces of good news from the report had big caveats attached. For instance, the acceleration in consumption was partly due to a sharp drop in the savings rate, the latter falling to a two-year low of 3.9%. That does not bode well for future consumption spending, particularly if, as we expect, the labour market softens. It’s also unclear if the uptrend in residential investment is sustainable."
NBF end by forecasting a likely contraction in Q2 due to growth already being battered by the Alberta Wildfires as well as the negative pass-through from the lacklustre growth in Q1.
Concerns that the GBP to CAD conversion's recovery has now overshot will likely be confirmed over coming days.
An interesting development in the G10 forex space over the past week was the outperformance of both the Canadian dollar and pound sterling.
Sterling was the top performer while the Canadian dollar came in second.
Interestingly, the CAD outperformed its fellow commodity dollars the Aussie and the Kiwi. The kiwi was the worst performer while the Aussie was the third worst performer.
The GBP and CAD therefore are evenly matched going into the coming week.
However, a bearish pattern on the charts, a risk UK PMI data will disappoint, the possibility Canadian Q1 GDP could impress and oil may continue higher, all tilt the bias to the downside for the GBP/CAD pair in the coming week.
From a purely technical poind of view, the pair may have formed a head and shoulders (H&S) topping pattern, made up of three peaks, with the head the highest, on the four-hour chart (shown below).
A break below the neckline of the H&S at 1.9039 would provide confirmation that the pair was moving lower, to an initial target at 1.8815, which is 61.8% of the height of the pattern, and the minimum price expectation.
Alternatively, assuming the neckline is not breached, the pair will probably continue sideways or higher, in line with the dominant up-trend; and a break above the 1.9300 highs would probably lead to a move up to the next target at the next major round-number at 1.9400.
Scotiabank’s Shaun Osborne also sees an H&S pattern, although he is more generous with his targets:
“If the daily price picture looks indecisive, the short-term signals are clearer (a bearish H&S top, with 1.8990 neckline on the 6-hour chart, targets 1.87 on a break lower) and backed up by a clear warning (“gravestone” doji) on the weekly charts. Near-term GBP risks are tilting lower.”
Osborne notes GBPCAD is vacillating just above support at 1.90.
"This is the “stop loss” on our bullish view of the cross — even though the rebound in the GBP in the past few weeks has largely conformed to our expectations (we targeted a rally to 1.91/1.92) we had recently thought that the move up could over-shoot," says Osborne.
All Eyes on Canadian Growth Data
From a fundamental perspective the highlight of the coming week is Canadian first quarter GDP growth figures, published on Tuesday May 31.
Growth in Q2 was 0.2% but according to tradingeconomics.com it is forecast to rise at a more rapid 0.4% in Q1. Canadian GDP data - unlike US is only published once - not twice in the form of an initial preliminary, followed by a final estimate.
Clearly, a higher-than-expected figure would be positive for the loonie (which means negative for the GBP/CAD) pair.
According to analysts at NBF Economics (an offshoot of National Bank of Canada):
“Monthly readings to date suggest economic growth accelerated sharply in Q1.”
They go on to list the possible contributors to growth:
“Trade was a net contributor to growth thanks to exports which expanded at a much faster pace than imports. Consumption also seems to have picked up speed as evidenced by retail volumes which, despite March’s drop, posted the best quarterly performance since 2014. Residential construction appears to have contributed to growth based on strong housing starts in the quarter, particularly for single family homes.”
They highlight a likely fall in business investment as the potential spoiler, however:
“But all of those gains are likely to be offset somewhat by continuing declines in business investment. Indeed, imports of industrial machinery and equipment fell again in the first quarter. All told, GDP may have increased roughly 3% annualized in Q1.”
Indeed, the fairly strong growth story was reflected in results from the Canadian stock market, which showed most sectors except those linked to commodities on the rise:
“Profits of non-financials excluding energy actually reached a record level in Q1 2016. Over the period, manufacturing profits (excluding petroleum and coal products) were up $687 million, mostly explained by a combined $1.1 billion increase in food and soft drinks, motor vehicles and parts and chemical, plastics and rubber products, which dwarfed a $623 million plunge in primary metals.”
Outlook for Interest Rates
The main event in the previous week was the Bank of Canada BOC rate meeting which resulted in no-change in policy. Fears that a slow-down in the economy and a rapidly appreciating currency could put pressure on the BOC to lower rates further, were dismissed by NBF, who argued the pro-stimulus fiscal policies of the government combined with the BOC’s low interest rates are adequate:
“To our eyes, the fiscal and monetary policy mix at this point in time is appropriate for the economy’s ongoing structural adjustment.
With core inflation holding at close to 2% as a result of continued lift from past exchange-rate depreciation, we see the Bank leaving its policy stance untouched until late next year.”
Outlook for Oil
Oil is a major contributor to the valuation of the Canadian Dollar, as it is its primary export: When oil prices rise, so does the loonie most of the time, when it falls, the Canadian Dollar often follows suit. As such an analysis of oil for the week ahead is useful for an analysis of the Canadian currency.
The main event for oil, apart from the usual inventory data, will be the meeting of OPEC on Thursday June 2, however, this is unlikely to result in a supply freeze according to analysts at Lloyds, who posit the lack of consensus as the primary reason.
Lloyds are fairly bullish about oil seeing rising emerging market demand and supply outages due to wildfires in Canada and slowing Nigerian production as leading to a “rebalancing” of the market during 2016. They see further risks from political turmoil in Venezuela limiting production there:
“Lower US production, combined with unplanned outages in both Nigeria and Canada over the past month, increase the probability that crude oil markets will move back into balance this year. Meanwhile, there is growing risk of further disruption as the escalating political crisis in Venezuela, threatens another 2.4 mb/d of global supply and could potentially lead to a deficit.
“For a market focused on oversupply since the middle of 2014, the recent positive price impact from supply disruption highlights the sea shift change in sentiment. Demand is similarly proving constructive base for crude oil to move higher. Global crude oil demand grew by 1.4 mb/d in Q1 compared with the same period last year, higher than was predicted by the IEA. This was in large part due to EM demand, helping to assuage concerns around the impact of slowing economic growth on fuel consumption. We forecast Brent and WTI will average $55/bbl and $54/bbl in Q4, respectively, but the risks to our forecasts have shifted to the upside.”
Analysis of Sterling
The main event for sterling will be the triumvirate of purchasing manager surveys (PMI’s) released, including Manufacturing, Services and Construction.
The fall below 50 in manufacturing PMI in the previous month of April was a particularly negative sign, which shows that the manufacturing sector is contracting (over 50 = expansion; under 50 = contraction).
If PMI’s for May continue to show weakness this will probably weigh on the pound because it will lower the possibility that the Bank of England (BOE) will raise interest rates sooner than expected.
Higher interest rates support a currency as they increase capital flows into the country due to the higher return offered.
Some analysts have argued that the fall in PMI’s is as a result of Brexit fears, which have contributed to a fall in direct foreign investment. If they are right then PMI’s should bounce back if the referendum vote returns a ‘Stay’ win, as bookmakers still probably expect.
If PMI weakness is not due to Brexit concerns, however, then Economist Roger Bootle, argues it could substantially delay interest rate expectations, as PMI’s are currently at such a low level which, “in the past has often triggered interest rate cuts from the MPC.”
Latest Referendum news
The latest Brexit polls have been highly mixed, with yesterday’s YouGov poll showing a close race between ‘Stay’ and ‘Leave’, but a poll published overnight by Lord Ashcroft revealing over 60% of people still expect the Remain camp to win.
The Ashcroft poll also shows most people say they are likely to base their final decision on “gut feel” rather than “facts and figures”.
We think this may result in a higher-than-expected vote for ‘Leave’, as its more emotive, reactionary, and patriotic political associations, which are generally viewed as more ‘instinct’ driven than ‘rational’.
Whatever the polls are saying the race is likely to be close run, and the result unknowable until the day after the actual vote.