Loonie to benefit from better U.S. and global growth next year

TORONTO, July 8, 2013 /CNW/ - The Canadian dollar will not suffer the fate of the Australia currency and will hold near current levels through 2013 while seeing a rebound to parity by the end of next year, finds a new report from CIBC World Markets Inc.

"As we expected, the Canadian dollar has been a casualty of disappointing global growth this year, moving even earlier than we forecast to our target of five cents weaker than parity," says Avery Shenfeld, Chief Economist at CIBC. "But that now has some momentum-style forecasters piling on even more damage ahead. Instead, while normal volatility will no doubt see days with the Canadian dollar a cent or two weaker than today's levels, we view the bout of Canadian dollar softness this year as an opportunity to buy it ahead of a likely appreciation in 2014."

Unlike a number of forecasters, Mr. Shenfeld does not believe the loonie will suffer the same drop as the Australian dollar. "The deeper dive suffered by the Australian dollar, from US$1.06 in mid-January to 0.91 today, is oft cited as foretelling the Canadian currency's fate, as the two are seen as twins by many traders.

"Analogies to the Australian dollar's steeper setback are overdone, as the currencies are more like distant cousins than twins in terms of the economic fundamentals. While both are in the so-called "dollar bloc" (an empty phrase in our view based only on the name of the currency), and both countries are developed, commodity exporting nations with historical ties to the UK, on other key fundamentals, the gaps are as wide as their geographic separation."

In the report, Mr. Shenfeld and CIBC Economist Andrew Grantham write that it's been many years since the two countries were in the same phases of the business cycle. They note that while Canada faired better than most industrial nations, it still experienced a serious recession in 2008/9 - something Australia managed to escape. As a result, the central banks in the two countries have been on very different courses. When Canada's interest rates were pushed to record lows, Australian rates were rising to combat inflationary pressures.

So while both currencies were hit this year by the implications of soft global growth on commodity prices, Australia was further hit by the decision by its central bank to cut interest rates in response to weaker Australian growth. That's a story that's not in the cards for Canada given the much lower starting point for central bank rates, and the Bank of Canada's reluctance to add fuel again to household borrowing.

But they also point out that the export focus of Canada is much more varied than that of Australia. Australia's top six exports are all commodities and resources account for around three-quarters of all outbound shipments. Iron ore and coal are the countries leading exports. In Canada, resources still make up less than half of exports, with manufactured products still hanging on to a major role. The country's top exports are oil, vehicles/parts and machinery.

"While resource prices are correlated given their link to the global business cycle, price trends do diverge," notes Mr. Shenfeld. "Disappointing growth in China, and a shift in its mix towards less resource-using sectors like services, will continue to play much more negatively for Australia's export prices and related capital spending.

"China accounts for a whopping two-thirds of global iron ore imports—Australia's key export. In contrast, China's import share in oil, Canada's export heavyweight, remains much smaller. The result of Australia's greater commodities reliance, and specifically to goods tied to Chinese demand, is that China's boom and slowdown have led to a much higher spike and deeper tumble for Aussie export prices."

The report notes that while Canada's oil reliance brings its own vulnerabilities, the CIBC economists expect crude oil to average $98 per barrel next year, helped by improving global growth, even if Mideast politics settle down a bit. "One would have to be a huge bear on prices for oil and Canadian manufactured goods to have Canada face as much damage to its terms of trade as that suffered by Australia since mid-2012," adds Mr. Shenfeld. "The only equivalent for Canada in recent decades was in fact the Great Recession, which included a dive in oil prices to less than $40 per barrel."

The CIBC economists believe Canada faces a potentially more favourable external environment in the coming year, given its greater tie to the U.S. With a lower drag from fiscal policy and further improvement in homebuilding, they think the U.S. economy could see a noticeable acceleration next year and forecast growth of 3.3 per cent vs 1.8 per cent in 2013. In contrast, they expect only a moderate acceleration in China—Australia's key export driver.

"The Canadian dollar should be a beneficiary of better U.S. and global growth next year," says Mr. Shenfeld. "Talk of an imminent tapering of QE by the Fed appears overdone, and the tap will not be completely turned off until the U.S. economy is strong enough. Look for the Canadian dollar to stabilize near current levels in the last half of this year, a buying opportunity ahead of a trade-driven appreciation back to parity in 2014."

The complete CIBC World Markets report is available at:
http://research.cibcwm.com/economic_public/download/eijul13.pdf.

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SOURCE: CIBC World Markets