Canadian Dollar

Highlights Central bankers appear to be in a rush to boost inflation expectations before the next economic downturn. This in practice should be stimulative for the global economy. Historically, currencies of small, open economies are typically the first to benefit from rebounding global growth. Ditto for those whose output gaps have fully closed. However, there appears to be a shift in the behavior of certain currency pairs in the current cycle. For example, the U.S. dollar has tended to perform better in a low-volatility environment in recent years, a shift from the past. Correspondingly, its safe-haven status may have been marginally eroded. The U.S. decision not to extend waivers on Iranian oil exports beyond the May 2 deadline is bullish for petrocurrencies such as the RUB and NOK. The Bank of Canada kept rates on hold but will be hard pressed to meet its inflation mandate before the next downturn. This suggests standing aside on USD/CAD. Rising net short positioning on the yen and Swiss franc is making them attractive from a contrarian standpoint. Place a limit-buy on CHF/NZD at 1.45. Feature Chart I-1Volatility Is Due For A Bounce The four most important financial variables that could give a near-complete snapshot of the world economy at any point in time are probably the level of the S&P 500, the U.S. 10-year Treasury yield, the trade-weighted dollar and a commodity bellwether, say, crude oil prices. Any permutation of these variables can identify what quadrant the world economy is operating in, with the two most important states being either boom or bust. Taking three of those variables today – the S&P 500 breaking to all-time highs, crude oil prices up 40% from their lows and U.S. 10-year Treasury yields off by almost 100 basis points from their October highs – it is hard to justify why the dollar has hardly budged, this week’s rally aside. Obviously, this is a very simplified view of an intricately complex world economy. But it highlights a point we have been making in recent bulletins: that extended periods of low currency volatility have been very unusual in the post-Bretton Woods world (Chart I-1). The typical narrative has been that as we enter a reflationary window, pro-cyclical currencies should outperform. The reason is simple enough: These economies are export-oriented and tied to the global cycle. So, a rising current account surplus as demand for their goods and services picks up provides underlying support for the currency. Should there be little slack in their domestic economies, this also raises the probability that the central bank tightens monetary policy to fend off future inflationary pressures. It does not hurt if these countries are also commodity producers, since rising terms of trade also provides an additional exchange-rate boost. The reality is that the world is not static, and some of these dynamics have been shifting. The evidence is in the counterfactual: At current levels, China’s credit injection should have lit a fire under pro-cyclical trades because they tend to work in real-time rather than with a lag. The foreign exchange market is one of the deepest and most liquid where new information tends to get digested and discounted instantaneously. As such, the lack of more pronounced strength in pro-cyclical currencies like the Australian, New Zealand and Canadian dollar exchange rates is genuine reason for concern and worth investigation. Why Is The Dollar Breaking Higher? Our Special Report1 on March 29th highlighted the fact that the dollar should be 5-10% higher simply based on measures of relative trends, and recent data corroborate this view. The growth differential between the U.S. and the rest of the world remains wide. Meanwhile, exports and industrial production from Southeast Asia continue to decelerate. Interbank rates in China are spiking higher, suggesting most of the monetary stimulus may have already been frontloaded. And on the earnings front, U.S. profit leadership also continues. It is unclear which of these catalysts was the actual trigger for dollar strength, since these have been in place for a while now, but confirmation from any and all of them was sufficient to reinvigorate the dollar bulls. That said, it is important to pay heed to shifting market forces, but it will be imprudent to change investment strategy on this week’s moves alone. Given these moves, a few observations are in order: Almost all currencies are already falling versus the U.S. dollar – a trend that has been in place for several months now (Chart I-2). This means most of the factors putting upward pressure on the dollar are well understood by the market. For example, global growth has been slowing for well over a year, based on the global PMI. Putting on fresh U.S. long positions is at risk of a washout from stale investors, just as it was back in 2015, a year after growth had peaked. Dollar technicals are also very unfavorable (Chart I-3). Speculators are holding near-record long positions, sentiment is stretched and our intermediate-term indicator is also flagging yellow. Over the past five years, confirmation from all three indicators has been followed by some period of U.S. dollar indigestion. This time should be no different. Chart I-2Is It Time To Initiate Fresh Dollar Longs? Chart I-3Dollar Technicals Are Unfavourable A breakout in the dollar along with rising equity markets suggests that the correlation is once again shifting. The dollar has tended to trade as a counter-cyclical currency for most of the time, with a negative correlation even to global equities (Chart I-4). Importantly, given current low levels of volatility and elevated equity market valuations, the dollar would have been a great insurance policy for any stock market correction. But with U.S. interest rates having risen significantly versus almost all G10 countries in recent years, the dollar has itself become the object of carry trades. This has also come with a good number of unhedged trades, as the rising exchange rate has lifted hedging costs (Table I-1). Chart I-4The Dollar Remains A 'Risk-Off' Currency It will be difficult for the dollar to act as both a safe-haven and carry currency, because the forces that drive both move in opposite directions. For one, safe-haven assets tend to be lower-yielding but also during episodes of capital flight, investors choose to repatriate capital to pay down debt, with creditor nations having the upper hand. And given U.S. investors have already been repatriating close to $400 billion in assets over the past 12 months, it is unlikely this pace persists (Chart I-5). The bottom line is that investors who believe that the U.S. dollar has become a high-beta currency should be prepared to stampede out the door on any rise in volatility. Our bias remains that the U.S. dollar will ultimately weaken, given that the forces driving it higher are mostly behind us. Meanwhile, currencies such as the Japanese yen or even Swiss franc that have been used to fund carry trades are very ripe for short-covering flows. Putting everything together suggests at minimum building portfolio hedges. It will be difficult for the dollar to act as both a safe-haven and carry currency. One such hedge is going long CHF/NZD. This trade has a high negative carry, so we do not intend to hold it for longer than three months. But speculative positioning and relative economic trends also support this cross for the time being (Chart I-6). We are placing a limit-buy at 1.45. Chart I-5How Much More Will Repatriation Flows Help? Chart I-6CHF/NZD Is An Attractive ##br##Hedge A Shifting Landscape If the dollar eventually weakens, let’s consider the premise that the most export-dependent economies should benefit more from a rebound in global growth, and by extension, their currencies should appreciate the most. Within the G10 universe, this will be notably the European currencies led by the Swiss franc, the Swedish Krona, the euro and the pound (Chart I-7). However, from the trough in the global Purchasing Managers’ Index (PMI) in December 2008 until the peak in April 2010, it was the commodity currencies that outperformed. During that time frame, the Swiss franc actually fell. It is well known that Switzerland’s persistent trade surplus over the decades has been a key factor behind structural appreciation in the currency. However, at any point in time, other nuances such as whether the rebound is China or commodities driven, the starting point for valuations or even interest rate differentials take center stage in explaining currency moves. The lesson is that investors have to become nimble with currency investment strategy. The lesson is that investors have to become nimble with currency investment strategy. For pro-cyclical currencies, there have been dramatic shifts in the export share of GDP for various countries, according to World Bank data. Most euro area countries have massively expanded their export share of GDP as they have gained ground in value-added products and services. Meanwhile, the export share in Australian GDP has been stuck at 20% for many years, while that in Norway, New Zealand and Canada has seen a huge drop, even since 2009 (Chart I-8). At first blush, this suggests diminishing marginal returns to their currencies from global growth. Chart I-8A Shifting Export ##br##Landscape Take the example of New Zealand, where commodities are over 75% of exports. Since the 2000s, the government has been actively trying to redistribute growth from net exports to domestic demand. This has been mainly via the skilled workers program. The result has been a collapse in the export share of GDP from 36% to about 26%. This means that the New Zealand dollar, which has typically been a higher-beta play on global growth, is giving way to other currencies such as the euro and the Swedish krone (Chart I-4). In addition to this, while global growth might eventually recover, part of the widespread deterioration since the global financial crisis may be structural. If the overarching theme over slowing global trade is a global economy that is trying to lift its precautionary savings and spend less, then the world may not see the high rates of trade growth registered in the 1990s anytime soon. This is because at a lower rate of potential GDP growth, trade elasticities also tend to fall.2 There are many reasons for this, including less willingness among creditor nations to finance current account deficits, the paradox of thrift or just outright saturation in the turnover of trade. All of this dampens marginal returns toward all pro-cyclical currency trades. Chart I-9Trade Volatility Has Fallen The bottom line is that the overall magnitude and volatility of trade relative to GDP has fallen, at least until the recent China – U.S. trade spat (Chart I-9). This has had the effect of dampening the volatility of the corresponding mediums of trade exchanges. Part of this is clearly cyclical, but a part may be structural as well. If we embrace confirmation that the Chinese economy has bottomed, it will be important to monitor if this cycle plays out like those in the past. Notes On Petrocurrencies, And The BoC The U.S. has decided not to extend waivers on Iranian oil exports beyond the May 2 deadline. Supposedly, a coalition with both Saudi Arabia and the United Arab Emirates would ensure that oil markets remain adequately supplied, though Saudi Arabia has since signaled they are in no rush to raise production. Overall, this increases the bullish narrative for oil. First, the Iranian response to a shutoff in their exports could be unpredictable. The U.S. threat of driving Iranian oil exports to zero increases the geopolitical risk premium in prices, as full implementation pushes Iran to a wall, raising the odds of retaliation. Chart I-10Iran Is A Meaningful Oil Supplier Second, oil production is being curtailed at a time when Venezuelan output is rapidly falling, conflict in Libya is reviving and OPEC spare capacity remains tight. This could nudge the oil market dangerously close to a negative supply shock (Chart I-10). Meanwhile, there is the non-negligible risk of unplanned outages which have been rising in 2019, which is another source of risk for oil supply Oil futures have responded positively to the news, with both Brent and WTI making fresh 2019 highs. However, while initially reacting favorably, petrocurrencies such as the Canadian dollar, Russian ruble and Norwegian krone are selling off amid dollar strength. We think Brent will continue to trade at a premium to WCS crude. This bodes well for currencies tied to North Sea production. Hold short CAD/NOK and long NOK/SEK positions, despite the selloff this week. As for Canada, we are neutral on the loonie both short and medium term. The dovish shift by the BoC and looser fiscal policy are likely to be growth tailwinds. So is the rise in oil prices. However, there appears to be a genuine slowdown in the Canadian economy that is not yet fully reflected in economic forecasts.  The key drivers for the CAD/USD exchange rate are interest rate differentials with the U.S. (which we think will compress further) and energy prices (which we think Canada benefits less from due to the discount Canadian oil sells for, and persistent infrastructure problems). As such, we think domestic conditions will continue to knock down whatever benefit comes from rising oil prices (Chart I-11). Chart I-11CAD/USD Will Benefit From##br## Rising Terms Of Trade Chart I-12Can The BoC Hike Given ##br##This Backdrop? (1) On the consumer side, real retail sales are deflating at the worst pace since the financial crisis, and demand for housing loans is falling off (Chart I-12). This is unlikely to improve if house prices continue to roll over (Chart I-13). A study by the Reserve Bank of New Zealand shows that on average, the elasticity of consumption growth to house price changes is asymmetric with negative housing shocks, hurting consumption by more than the boost received from positive shocks. This asymmetry may be due to the fact that at very elevated debt levels, leveraged gains are used to pay down debt aggressively, whereas leveraged losses hit bottom lines directly. There appears to be a genuine slowdown in the Canadian economy that is not yet fully reflected in economic forecasts. On the corporate side of the equation, the latest Canadian Business Outlook Survey is very telling. Firms’ expectations for sales have softened significantly, as businesses in several sectors are less optimistic about demand. This is driven by uncertainty in the oil patch, weak housing and weak external conditions. This in turn, has led to a steep drop in plans to increase capex (Chart I-14). For external investors, the large stock of debt in the Canadian private sector and overvaluation in the housing market are likely to continue leading to equity outflows on a rate-of-change basis. Chart I-13Can The BoC Hike Given This Backdrop? (2) Chart I-14Can The BoC Hike Given This Backdrop? (3) Technically, USD/CAD failed to break below the upward sloping trendline drawn from its 2017 lows. The next resistance zone is the 1.36-1.38 level. Our bias is that this zone will prove to be formidable resistance. We continue to recommend investors short the CAD, mainly via the euro. Housekeeping Our limit-buy on AUD/USD was triggered at 0.70. Place tight stops at 0.68 until further evidence that global growth has bottomed. Our short USD/SEK position garnered losses this week. The RiksBank’s dovish shift surprised the market, and triggered panic selling as important technical levels were broken. With a manufacturing PMI at 52.8, inflation at 1.8% and wages growing near 3%, this is not exactly the symptoms of an economy that needs more stimulus. We recommend holding onto positions, but will respect our stop loss a few hundred pips away. Finally, the dovish shift by the Bank of Japan does not change our thinking on the yen. The resilience in the currency might indicate the pool of yen bears has been exhausted.   Chester Ntonifor, Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see Foreign Exchange Strategy Special Report, titled “Tug Of War With Gold As Umpire,” dated March 29, 2019, available at fes.bcaresearch.com. 2 Cristina Constantinescu, Aaditya Mattoo, and Michele Ruta, “The Global Trade Slowdown: Cyclical Or Structural?” IMF working paper (2015). Currencies U.S. Dollar Chart II-1 Chart II-2​​​​​ Recent data in the U.S. suggest a weaker housing market: In March, building permits contracted by 1.7% month-on-month, falling to 1.27 million; housing starts decreased by 0.3% month-on-month, coming in at 1.14 million. March new home sales grew by 4.5% month-on-month, coming in at 0.69 million. However, existing home sales contracted by 4.9% month-on-month, falling to 5.21 million. The house price index grew by 0.3% month-on-month in February, in line with expectations. MBA mortgage applications decreased by 7.3% in April. The Chicago Fed National Activity index fell to -0.15 in March, underperforming expectations. Durable goods orders increased by 2.7% in March, surprising to the upside. DXY index appreciated by 1% this week, hitting the highest level since June 2017. While a more accommodative monetary policy stance has been taken in China, global growth momentum remains weak, which is a cause for concern. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 Tug OF War, With Gold As Umpire - March 29, 2019 The Euro Chart II-3 Chart II-4 Recent data in the euro area continue to soften: Italian business confidence and consumer confidence in March fell to 100.6 and 110.5, respectively. April preliminary consumer confidence in the euro area fell to -7.9, below expectations. German IFO business climate fell to 99.2 in April; expectations and current assessment fell to 95.2 and 103.3, respectively. French business confidence improved to 105, while business climate decreased to 101 in April. Italian trade balance came in at a larger surplus of 3.42 billion euro in April. EUR/USD depreciated by 1% this week. The incoming data from the euro area and globally have been weaker than expected. The recent ECB Economic Bulletin remains positive for the growth outlook going forward, stating that “the supportive financing conditions, favorable labor market dynamics and rising wage growth should continue to underpin the euro area expansion.” Report Links: Reading The Tea Leaves From China - April 12, 2019 Into A Transition Phase - March 8, 2019 A Contrarian Bet On The Euro - March 1, 2019 The Yen Chart II-5 Chart II-6 Recent data in Japan have been negative: Headline inflation and core inflation were unchanged at 0.5% and 0.4% year-on-year in March, respectively. Machine tool orders in March contracted by -28.5% year-on-year. All industry activity index fell by 0.2% month-on-month in February, in line with expectations. USD/JPY surged initially by 0.4% ahead of BoJ’s rate decision, then fell sharply, returning flat this week. The BoJ has decided to keep the interest rate on hold at -0.1%. The shift to a calendar-based form of forward guidance is unlikely to be a game-changer on its own. Moreover, the BoJ expects the Japanese economy to pick up through 2021 supported by highly accommodative financial conditions and government spending, despite the weakness of global growth and scheduled consumption tax hike. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Tug OF War, With Gold As Umpire - March 29, 2019 A Trader’s Guide To The Yen - March 15, 2019 British Pound Chart II-7 Chart II-8 Recent data in the U.K. have been positive: Public sector net borrowing increased to 0.84 billion pounds in March. In April, the CBI retailing reported sales increased to 13. The CBI business optimism came in at -16 in April, an improvement compared to the last reading of -23. GBP/USD fell by 1% this week, mostly affected by the U.S. dollar’s broad strength. The pound is likely to rebound once we see more signs confirming the strength in global growth, given Brexit has been kicked down the road. Report Links: Not Out Of The Woods Yet - April 5, 2019 A Trader’s Guide To The Yen - March 15, 2019 Balance Of Payments Across The G10 - February 15, 2019 Australian Dollar Chart II-9 Chart II-10 Recent data in Australia have been negative: Headline inflation fell to 1.3% year-on-year in Q1, missing expectations. Trimmed mean inflation in Q1 fell to 1.6% year-on-year. AUD/USD fell by 2.3% this week, which triggered our limit buy order at 0.7 on Wednesday. Inflation is a lagging indicator. While the Q1 inflation number missed expectations, the Australian dollar is likely to bottom as Chinese stimulus plays out and global growth starts to pick up. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 Into A Transition Phase - March 8, 2019 New Zealand Dollar Chart II-11 Chart II-12 Recent data in New Zealand has been negative: Credit card spending contracted by 5.1% year-on-year in March, underperforming expectations. NZD/USD fell by 1.36% this week. We remain bearish on the New Zealand dollar due to the Achilles’ heel of an overvalued housing market. Moreover, the Kiwi is still expensive compared to its fair value. Report Links: Not Out Of The Woods Yet - April 5, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Canadian Dollar Chart II-13 Chart II-14 Recent data in Canada have been positive: Wholesale sales grew by 0.3% month-in-month in February, surprising to the upside. CFIB business barometer increased to 56.7 in April. USD/CAD surged by 0.95% this week. The Canadian dollar seems to be less responsive to the energy prices this week due to lots of concerns regarding the pipeline issue in Alberta. The Bank of Canada maintained its overnight interest rate target at 1.75% on Wednesday. In the April Monetary Policy Report, the BoC projects real GDP growth of 1.2% in 2019, and around 2% in 2020 and 2021. Given the current developments in household spending, energy investment, and trade conditions, a dovish stance by BoC is warranted. Report Links: A Shifting Landscape For Petrocurrencies - March 22, 2019 Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 Swiss Franc Chart II-15 Chart II-16 Recent data in Switzerland have been mostly positive: Money supply M3 grew by 3.5% year-on-year in March, same as last month. ZEW survey expectations increased to -7.7 from the previous reading of -26.9. USD/CHF increased by 0.66% this week. While global growth is set to rebound, the uncertainties regarding geopolitical risks, trade conditions, and oil prices will weigh on the growth pace. We remain neutral on the Swiss franc against U.S. dollar, but acknowledge that the large short positioning is attractive from a contrarian standpoint. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Norwegian Krone Chart II-17 Chart II-18 There is no significant data from Norway this week. USD/NOK appreciated by 2.2% this week. We remain overweight the NOK based on our bullish outlook for oil. The Trump administration said they would not renew the waivers for Iranian oil exports, a move that roiled the energy market. The spike in oil prices will eventually benefit the Norwegian krone once global growth stabilizes. Report Links: A Shifting Landscape For Petrocurrencies - March 22, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Swedish Krona Chart II-19 Chart II-20 Recent data in Sweden suggest a more positive sentiment: Consumer confidence increased to 95.8 in April, surprising to the upside. Economic tendency survey increased to 102.7 in April. Moreover, the manufacturing confidence also improved to 108.4 in April. USD/SEK appreciated by 2.64% this week. The Riksbank has kept its interest rate unchanged at -0.25% this week, as widely expected. The dovish shift of central banks worldwide is likely to help the global economy, which will benefit the Swedish krona. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades

Highlights The correlation between oil and petrocurrencies has deeply weakened in recent years. One of the reasons has been the prominence of new, important producers, notably the U.S. Oil prices should trend towards $75/bbl by year-end. This will favor the NOK, but the CAD and AUD will be held hostage to domestic slowdowns. Sell the CAD/NOK at current levels. Meanwhile, aggressive investors could begin accumulating USD/NOK shorts, given the Fed’s complete volte-face. Both the SNB and the BoE have delivered dovish messages, joining the chorus echoed by other central banks. However, the BoE remains a sideshow until the final chapter of the Brexit imbroglio unfolds. Feature Oil price dynamics have tended to have a profound impact on the trend of petrocurrencies. In theory, rising oil prices allow for increased government spending in oil-producing countries, making room for the resident central bank to tighten monetary policy. This is usually bullish for the currency. An increase in oil prices also implies rising terms of trade, which further increases the fair value of the exchange rate. Balance-of-payments dynamics also tend to improve during oil bull markets. Altogether, these forces combine to be powerful undercurrents for petrocurrencies. In the case of Canada and Norway, petroleum represents around 20% and 60% of total exports. For Saudi Arabia, Iran or Venezuela, this number is much higher than in Norway. It is easy to see why a big fluctuation in the price of oil can have deep repercussions for their external balances. Getting the price of oil right is usually the first step in any petrocurrency forecast. The Outlook For Oil1 Our baseline calls for Brent prices to touch $75/bbl by year-end. Oil demand tends to follow the ebbs and flows of the business cycle, with demand having slowed sharply in the fourth quarter of 2018 (Chart I-1). With over 60% of global petroleum consumed fueling the transportation sector, the slowdown in global trade brought a lot of freighters, bulk ships, large crude carriers and heavy trucks to a halt. If, as we expect, the impact of easier global financial conditions begins to seep into the real economy, these trends should reverse in the second half of the year. BCA’s Commodity & Energy Strategy group estimates that this would translate into a 1.5% increase in oil demand this year. Chinese oil imports have already started accelerating, and should Indian consumption follow suit, this will put a floor under global demand growth (Chart I-2). Chart I-1Global Oil Demand Has Been Weak Chart I-2Oil Demand Green Shoots This increase in oil demand will materialize at a time when OPEC spare capacity is only at 2%. In its most recent meeting, OPEC decided not to extend the window for production cuts beyond May, waiting to see whether the U.S. eases sanctions on either Venezuela, Iran or both. At first blush, this appeared bearish for oil prices. However, the bottom line is that global spare capacity cannot handle the loss of both Venezuelan and Iranian exports. Unplanned outages wiped off about 1.5% of supply in 2018. Lost output from both countries will nudge the oil market dangerously close to a negative supply shock (Chart I-3). Bottom Line: If Venezuelan sanctions continue, we expect the U.S. will likely extend the current waivers to Iranian exports further out into the future. Meanwhile, demonstrated flexibility by OPEC makes it increasingly the fulcrum of the oil market. That said, the balance of risks for oil prices remain to the upside since a miscalculation by both sides is a possibility. The Good Old Days Historically, the above analysis would have been largely sufficient to buy most petrocurrencies, especially given the gaping wedge that has opened vis-à-vis the price of oil (Chart I-4). But the reality is that the landscape for oil production is rapidly shifting, with the U.S. shale revolution grabbing market share from both OPEC and non-OPEC members. Chart I-4Opportunity Or Regime Shift? In 2010, only about 6% of global crude output came from the U.S. Collectively, Canada, Norway and Mexico shared about 10% of the oil market. Meanwhile, OPEC’s market share sat just north of 40%, having largely been stable among constituents like Saudi Arabia, Iran and even Venezuela. Fast forward to today and the U.S. produces almost 15% of global crude, having grabbed market share from both developed and politically-fragile economies (Chart I-5). Chart I-5A New Oil Baron At the same time, the positive correlation between petrocurrencies and oil has been gradually eroded as the U.S. economy has become less and less of an oil importer. Put another way, rising oil prices benefit the U.S. industrial base much more than in the past, while the benefits for countries like Canada and Norway are slowly fading. U.S. shale output in the Big 5 basins rose by about 1.5 million barrels in 2018, close to the equivalent of total Libyan production. Meanwhile, Norwegian production has been falling for a few years.  The reality is that the landscape for oil production is rapidly shifting, with the U.S. shale revolution grabbing market share from both OPEC and non-OPEC members. In statistical terms, petrocurrencies had a near-perfect positive correlation with oil around the time U.S. production was about to take off (Chart I-6). Since then, that correlation has fallen from around 0.8 to around 0.3. At the same time, the DXY dollar index is on its way to becoming positively correlated with oil as the U.S. becomes a net energy exporter. Chart I-6Shifting Landscape For Petrocurrencies Bottom Line: Both the CAD and NOK remain positively correlated with oil. So do the Russian ruble, and the Colombian and Mexican pesos. That said, a loss of global market share has hurt the oil sensitivity of many petrocurrencies. Transportation bottlenecks for Canadian crude and falling production in Norway are also added negatives. The conclusion is that rising petrodollar reserves have historically been bullish for the currency (Chart I-7) but expect this correlation to be weaker than in the past.  Chart I-7Rising Petrodollar Reserves Will Be Bullish The Fed As A Catalyst The Federal Reserve recently completed the volte-face that it launched at its January FOMC meeting. The dots now forecast no rate hikes in 2019 and only one for 2020. Previously, three hikes were baked in over the forecast period. GDP growth has been downgraded slightly, and CPI forecasts have also been nudged down. Rising petrodollar reserves have historically been bullish for the currency but expect this correlation to be weaker than in the past. The reality is that U.S. growth momentum relative to the rest of the world started slowly rolling over at a time when external demand remained weak.2 Recent data confirm this trend persists: Industrial production peaked last year and continues to decelerate; the NAHB housing market index came in a nudge below expectations; and the U.S. economic surprise index is sitting close to its one-year low of -40. With bond yields having already made a downward adjustment by circa 100 basis points, the valve for financial conditions to get looser could easily be via the U.S. dollar (Chart I-8). We have been selectively playing USD shorts, mostly via the SEK and the euro, as per our March 8th report. Today, we add the Norwegian krone to the list. Chart I-8Bond Yields Down, Dollar Next? Sell CAD/NOK The Norges Bank hiked interest rates to 1% at yesterday’s meeting, which was widely expected, but the hawkish shift took the market by surprise. Governor Øystein Olsen signaled further rate increases later this year, at a time when global central banks are turning dovish. This lit a fire under the Norwegian krone. The 6.60 level for the CAD/NOK has proven to be a formidable resistance since 2015.   The Norwegian economy remains closely tied to oil, with the bottom in oil prices in 2016 having jumpstarted employment growth, business confidence and wage growth. With inflation slightly above the central bank’s target and our expectation for oil prices to grind higher, we agree with the central bank’s assessment that the future path of interest rates is likely higher (Chart I-9). Chart I-9The Norwegian Economy Is Faring Well Our recommendation is that NOK long positions should initially be played via selling the CAD, as an indirect way to express USD shorts (Chart I-10). The 6.60 level for the CAD/NOK has proven to be a formidable resistance since 2015, and our intermediate-term indicators suggest the next move is likely lower. Meanwhile, relative economic surprises are moving in favor of Norway, with export growth, retail sales and employment growth all outpacing Canadian data. The discount between Western Canadian Select crude oil and Brent has closed, but our contention is that the delay in Enbridge’s Line 3 replacement will likely push the discount back closer to $20/bbl. Chart I-10Sell USD Via CAD/NOK Over the longer term, both the Canadian and Norwegian housing markets are bubbly, but in the latter it has been concentrated in Oslo, with Bergen and Trondheim having had more muted increases. In Canada, the rise in house prices could rotate to smaller cities, as macro-prudential measures implemented in Toronto and Vancouver nudge investors away from those markets (Chart I-11).  Chart I-11Bubbly Housing In Norway And Canada The Canadian government has decided to provide residents with a potential line of credit in exchange for equity stakes of up to 10% in residential homes. The maximum home value that qualifies for this line of credit has been capped at C$480,000. While this does little to improve the affordability of houses in expensive cities, it almost guarantees that those in competitive markets will be bid up. This will encourage a continued buildup of household leverage. Historically, when the leverage ratio for Canada peaked vis-à-vis the U.S., it was a negative development for the Canadian dollar (Chart I-12).   Chart I-12The CAD Looks Vulnerable Bottom Line: Go short CAD/NOK for a trade, but more aggressive investors should begin accumulating short positions versus the U.S. dollar outright. Hold USD/SEK shorts established a fortnight ago, currently 3% in the money. Housekeeping We are taking profits on our short AUD/CAD position this week, with a 1.4% profit. As highlighted in our March 8th report, the Australian dollar has been severely knocked down, and is becoming more and more immune to bad news. Despite home prices falling by more than 5% year-on-year, worse than during the financial crises, the Aussie was actually up on the week. Meanwhile, Australian exports will be at the top of the list to benefit from China’s reflationary efforts.   Chester Ntonifor,  Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see Commodity & Energy Strategy Weekly Report, titled “OPEC 2.0: Oil’s Price Fulcrum,” dated March 21, 2019, available at ces.bcaresearch.com 2 Please see Foreign Exchange Strategy Special Report, titled “Into A Transition Phase,” dated March 8, 2019, available at fes.bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 The recent data in the U.S. have shown more signs of a slowdown: February industrial production growth missed expectations, coming in at 0.1% month-on-month. Michigan consumer sentiment in March came in higher than expected at 97.8. NAHB housing market index in March came in at 62, below consensus. January factory orders slowed to 0.1% month-on-month.  Philadelphia Fed business outlook came in at 13.7, surprising to the upside. Initial jobless claims in March were 221k, also outperforming analysts’ forecast. The DXY index slumped by 0.8% post-FOMC, and is now slowly recovering on the strong data from the Philly Fed business outlook and initial jobless claims. The Fed left interest rates unchanged on Wednesday, while further signaling that no rate hike is likely through 2019. Moreover, 2019 GDP forecast was downgraded to 2%. The dovish turn by the Fed could weigh on the dollar in the coming weeks. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 The recent data in the euro zone have been mostly positive: February consumer price index came in line at 1.5% year-on-year; core consumer price index also stayed at 1% year-on-year. The seasonally-adjusted trade balance in January improved to 17 billion euros. Q4 labor cost fell to 2.3%. ZEW economic sentiment survey came in at -2.5 in March, outperforming the consensus of -18.7. EUR/USD increased by 0.5% this week. The FOMC-led sharp rebound sent EUR/USD to a new week-high of 1.145 on Wednesday. We expect more positive data coming from the euro zone, which will further lift the euro. Report Links: Into A Transition Phase - March 8, 2019 A Contrarian Bet On The Euro - March 1, 2019 Balance Of Payments Across The G10 - February 15, 2019 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have continued to soften: The merchandise trade balance came in at 339 billion yen in February. Total imports contracted by 6.7% year-on-year, while total exports fell by 1.2% year-on-year. Industrial production increased by 0.3% year-on-year in January. Capacity utilization in January fell by 4.7% month-on-month, missing expectations. The leading economic index in January fell to 95.9 from a previous reading of 97.2. USD/JPY slumped by 0.9% this week. Last Friday, the Bank of Japan left its key interest rate unchanged at -0.1%, as wildly expected. The 10-year government bond yield target also stayed unchanged at around 0%. Like many global central banks, the BoJ has been blindsided by the deep external slowdown that is beginning to seep into the domestic economy. Report Links: A Trader’s Guide To The Yen - March 15, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. have been mostly positive: Average earnings excluding bonuses in January grew in line by 3.4%. ILO unemployment rate in January fell to 3.9%. The retail price index in February stayed in line at 2.5% year-on-year. The February consumer price index increased to 1.9% year-on-year. Retail sales growth in February increased to 4% year-on-year, outperforming expectations.  GBP/USD fell by 1.1% this week, erasing the gains triggered by dollar weakness earlier on Wednesday. The BoE left its interest rate unchanged at 0.75%, and the sterling continues to show more volatility with a delayed Brexit. Report Links: A Trader’s Guide To The Yen - March 15, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have shown the housing market is toppling over: The housing price index in Q4 fell sharply by 5.1% year-on-year. New jobs created in February were 4,600, missing the expectations by 9,400. Moreover, 7,300 full-time employment jobs were lost, while 11,900 positions were created for part-time employment. The unemployment rate in February fell to 4.9%, while the participation rate decreased to 65.6%. AUD/USD appreciated by 0.6% this week. It pulled back a little after reaching a 0.7168 high on Wednesday following the dovish Fed decision. During a speech this week, RBA highlighted the concerns over the ability of households to service their debt. Both external and internal constraints remain headwinds for the Australian dollar. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been weak: Credit card spending growth in February slowed to 6.4% year-on-year. Q4 GDP growth came in at 2.3% year-on-year, underperforming consensus of 2.5%. The current account deficit widened to 3.7% of GDP in Q4. NZD/USD appreciated by 0.5% this week. The Q4 GDP breakdown showed that growth was mainly driven by the rise in service industries. Primary industries, however, fell by 0.8%. Agriculture was down 1.3%, mining was down 1.7%, forestry and logging fell 1.6%, and lastly, the fishing activity was down 0.9% quarter-on-quarter. The Kiwi will benefit from any dollar weakness, but is not our preferred currency. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Updating Our Intermediate Timing Models - November 2, 2018 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada continue to paint a mixed picture: January manufacturing shipments increased to 1% month-on-month. Foreign portfolio investment in Canadian securities saw an increase of C$49 billion in January, while Canadian portfolio investment in foreign securities decreased by C$8.4 billion. January wholesale sales growth increased to 0.6% month on month. USD/CAD rebounded overnight after falling sharply on a dovish Fed. CAD finally ended the week flat. On Tuesday, Bill Morneau, the Finance Minister of Canada, unveiled the new federal budget for 2019. It showed several new measures aiming to assist young and senior Canadian citizens, including first-time home buyers. While these measures might appease Canadian millennial voters, they will also result in significant deficits. The deficit projection for the year 2019-2020 widened to $19.8 billion, which could crowd out private spending. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 The trade balance in February came above expectations at 3,125 million CHF. Exports came in at 19,815 million CHF, while imports came in at 16,689 million CHF, respectively. USD/CHF depreciated by 1% this week. The Swiss National Bank left the benchmark sight deposit rate unchanged at -0.75%, as wildly expected. We struggle to see any upside potential for the franc, amid a dovish central bank, an expensive currency and muted inflation. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Waiting For A Real Deal - December 7, 2018 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway has been positive. The trade balance in February fell to 15.8 billion NOK, from a previous reading of 28.8 billion NOK. USD/NOK fell by 1.3% this week. The Norges Bank raised rates by 25 bps to 1%, in line with expectations, while signaling further rate hikes in the second half of this year. The Norges Bank once again demonstrated to be the most hawkish among G10 members. The bank reiterated that the economy is running at a solid pace and capacity utilization is above normal levels, while inflation keeps navigating above the bank’s target. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 There has been no major data release from Sweden this week. USD/SEK fell by 1.5% this week. Our short USD/SEK position is now 3% in the money since we initiated it 2 weeks ago. As we see more signs of recovery in the euro zone, we expect the exports of Sweden to pick up, which is a tailwind for the Swedish krona. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades