In my stock market book, Beyond the Bull, I emphasized the inter-connected nature of the financial markets. Everything is connected to everything else. At this stage in the cycles, the interconnected nature of the markets is playing seriously against Canada.
Over a year ago, the central banks of both Canada and U.S. talked about raising interest rates and controlling inflation. Earlier this year, they actually did raise interest rates. Why has The Bank of Canada (BOC) been more aggressive (three per cent increase) than The U.S. Federal Reserve Board (The FED) (two per cent increase)?
It’s because of the relative currencies. The U.S. Dollar is soaring versus the basket of non-U.S. currencies. As Yankee money rises, the Loonie falls. Since March, the Loonie has dropped almost nine per cent versus the U.S. Dollar and the U.S. Dollar has gone up 11 per cent versus the Basket of Non-U.S. Currencies.
This is particularly distressing because winter is approaching. In winter, Canada imports significantly more food than in summer. A weaker Loonie means that California vegetables will cost a lot more this winter. Food inflation will take a giant step up! This is directly against the wishes of the Bank of Canada. To achieve its inflation target, the BOC has to raise rates even more than it already has. The worse is yet to come.
Canadian Dollar vs. U.S. Dollar
Long term, the Canadian Dollar has been in a neutral sideways trading range since its climactic low in January 2016. Twice it has risen above 80 cents U.S., and twice it has declined again. In the 2020 COVID panic it dropped below 68 U.S. cents, and now, in the Russian-Ukrainian conflict, to 72 cents (so far…).
The Loonie had been relatively stable from January to mid-August of this year, showing only a modest down trend. Then, suddenly it dropped 4.4 per cent into September 30. Canada was caught up in the panic rush into the U.S Dollar, the “safe haven investment” in times of war and economic chaos. The long term trend is neutral, the short term: down.
U.S. Dollar vs. The Basket of Non-U.S. Currencies
This has been the star of the investment markets this summer. In April of this year, the U.S. Dollar broke out of a seven-year sideways trading range, erupting into a spectacular up trend, rising over 10 per cent in only six months.
All non-U.S. currencies declined against the Dollar: the Loonie was down 4.4 per cent since mid-summer. The Japanese Yen and British Pound declined over twice as much, making the Loonie one of the world’s stronger currencies. It is not clear whether this summer’s currency events are the beginning of a war-related currency crisis or a sudden re-adjustment of economic reality. The long-term trend of the U.S. Dollar is up!
Since the COVID-panic low in spring 2020, crude oil futures have risen from around US$20 a barrel to over US$130 in March of 2022. There was a sharp reversal down to US$93.50 and a feeble rally to US$122 in June.
Then a volatile down trend began. So far, the low has been US$76.50 in late September. Americans have seen a decline in gasoline prices – but, because of the dramatic decline of non-U.S. currencies, other nations have not enjoyed declining energy prices as much. Energy inflation is coming under control in the U.S., but not as much in other countries.
The down trend of oil prices often correlates to a down trend of the Loonie. Sometimes the Canadian Dollar becomes a petro-currency. If that occurs this winter, a weak Loonie will add even more to BOC’s food inflation problems. This, in turn, puts even more pressure on BOC to continue raising interest rates aggressively. This is a serious problem for Canadians.
Ken Norquay, CMT, is the author of the book Beyond the Bull, which discusses the impact of your personality on your long-term investments, i.e. behavioural finance.
This is an edited version of an article that was originally published for subscribers in the October 2022/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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The MoneyLetter •11/16/22 •