What could lift the loonie this year

Among the top 10 most-traded currencies, the loonie has been the best performing this year, recently gaining nearly 3.5% against the U.S. dollar.

At the beginning of the year, Richardson GMP noted that the loonie appeared oversold, so the firm expected some strength from the Canuck buck in 2019, if only in the short term.

Focusing on the short term has likely been the tactic for those aiming to earn income from the loonie over the last year and a half. The currency has traded within a well-defined channel against the U.S. dollar, as graphed by Richardson GMP in a weekly market insights report.

“Within the channel, there was the potential to add alpha by tactically hedging when the currency bumped up against the top and the bottom,” the report says.

To consider the loonie’s potential performance longer term, Richardson GMP lists the factors—both negative and positive—affecting the currency’s outlook.

One negative factor is interest rate differentials, which argue for a weaker loonie. The spread between U.S. and Canadian two-year bonds is approaching its widest level since 2006, at about 75 basis points.

“Higher rates attract global money flows, and right now U.S. bonds have the most pull,” the report says.

On the positive side are rising oil prices, with the recent lift in the commodities market helping to strengthen the Canadian dollar. So long as the rally in commodities and equity markets continues, it has the power to overcome the negative factor of interest rate differentials, the report says—though how long that rally lasts is unknown.

Another factor the firm considers is the futures market, where Canadian dollar sentiment has widened to a net short position of 5.6 billion contracts. Richardson GMP says this bearish bet is the largest since June 2017, and reflects a recent liquidation of bullish longs.

But, with bearish bets already made, further selling pressure is reduced, the firm says, providing a positive outlook for the loonie.

The firm concludes that the current environment is favourable for the loonie: “We wouldn’t be surprised to see further strength, though we would expect it to be temporary.”

For example, the rally will likely moderate at “first whisper of a hawkish comment from the Fed,” the report says. Plus, further volatility can be expected at this late stage of the cycle, which will prove positive for the U.S. dollar as a safe-haven currency.

As a result, “longer term, we remain U.S. dollar bulls,” the report says.

BMO and RBC forecast that the loonie will hover at about $1.33 this year—because of lower growth projections and a more cautious central bank, says BMO. (BMO forecasts one rate hike this year from both the Bank of Canada and Fed.) Likewise, CIBC forecasts $1.31 to $1.34. National Bank’s outlook offers more optimism, forecasting $1.28 at year-end if oil prices continue to rise and global trade fears ease.

For full details, read the report from Richardson GMP.