Canadian Dollar Extends Gains after Retail Sales Data Shows Households Weathering December Storm


Image © Bank of Canada

- CAD advances as consumers rescue economy from Dec contraction. 

- But fourth quarter still a soft one and BoC is growing unsure of itself.

- CIBC says CAD to weaken in 2019, as Morgan Stanley reiterates buy.

The Canadian Dollar extended gains in a market that was already supportive of risk assets Friday after retail sales data for the month of December showed households weathering a global economic storm in fine fashion, although analyst opinions still differ greatly on the outlook for the Loonie.

Markets already knew Canada's economy saw a soft finish to the 2018 year due to a sharp fall in oil prices and unease among businesses over President Donald Trump's trade war with China, but Friday's figures showed households were undeterred from spending ahead of the Christmas holidays.

Retail sales fell by -0.1% in December, extending a -0.9% decline from November, although markets had looked for a -0.3% contraction. The fall was mainly the result of a double-digit decline in oil prices having worked its way into prices charged for petrol at filling stations.

However, Statistics Canada said that if petrol sales were to be excluded from its data, retail spending would have risen by 0.4% during the final month of last year. In volume terms, which is what's important for GDP growth, sales were up by 0.2%.

Core retail sales, which remove large ticket items like car purchases from the data because of their distorting effect on underlying trends, declined by a much larger -0.5%. That was in line with consensus but extends an upwardly-revised -0.7% contraction from November. 

Much of Canada's retail spending growth came from motor vehicle and parts dealers in December, which is a sign of confidence among households, data shows. This could have saved the economy from another contraction in December. 

"The slight increase in volumes will see monthly GDP tracking forecasts around the 0.0% mark for December, which isn't great, but is better than what we had been fearing heading into the week. With real sales flat for the fourth quarter as a whole though, consumption won't be much of a contributor to overall growth in next week's GDP release. The modest positive surprise has been somewhat supportive of the loonie," says Royce Mendes, an economist at CIBC Capital Markets

There was abnormally high uncertainty around Canada's latest retail statistics because both headline and core numbers fell sharply back in November when in recent years at least, the Black Friday discounting period falling in that month had seen sales boosted, only for them to fall again in December. 

Currency markets care about the retail data because of the impact rising and falling demand has on inflation. It's changes in consumer price pressures that central banks are attempting to manipulate when they tinker with interest rates, which are themselves the raison d'être for most swings in exchange rates.

Changes in interest rates, or hints of them being in the cards, are only normally made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

The USD/CAD rate was quoted -0.22% lower at 1.3192 following the release after extending an earlier -0.02% gain, and is now down -2.9% for 2019.

Friday price action came in a risk-on market that was buoyed by what analysts say are signs of progress in talks to end the trade war between the U.S. and China. Markets are looking for a deal to end the tariff fight to be reached before a March 01 deadline, or for the deadline to be extended if the talks fail.

The Canadian Dollar remained the G10 universe's best performing currency for 2019 Friday, as it continues to be buoyed by a recovery of oil prices, even in spite of a soured outlook for Bank of Canada interest rate policy.

The Pound-to-Canadian-Dollar rate was -0.59% lower at 1.7149 and has now fallen by -1.58% this year.

"The Governor conceded that the path back to neutral is not clear at the moment. However, in sticking with their call that rates are scheduled to move higher at some point, the BoC is one of the few major central banks with a hawkish bias at the moment. However, in sticking with their call that rates are scheduled to move higher at some point, the BoC is one of the few major central banks with a hawkish bias at the moment," says CIBC's Mendes. 

The Bank of Canada (BoC) said in January it will be more cautious about raising rates than earlier guidance suggested it would. The message was clear in that it will move more slowly than before. 

But previously the bank said rates could rise to between 2.5% and 3.5% by early 2020, which led markets to believe as many as three rate hikes were in the cards for 2019 and explains why the Canadian Dollar fell so sharply between early December and the middle of January.

Governor Stephen Poloz said Thursday, in a speech to the Chamber of Commerce of Metropolitan Montreal, that Canada's current 1.75% interest rate is still low and providing stimulus to the economy. But he also said the path back to the neutral has become "less clear" amid multiple headwinds. 

"The Bank of Canada still seems inclined to find an excuse to hike rates, with one final hike possible in Q3 after an oil production recovery shows up in temporarily better GDP prints. That will keep the Canadian dollar better bid, towards a 1.31 low for dollar-Canada this summer," says Avery Shenfeld, chief economist at CIBC, in the bank's latest FX outlook.

Pricing in the overnight-index-swap market implies an October 30, 2019 cash rate of 1.78%, which is barely any higher than the current 1.75% rate actual rate and suggests strongly that investors have a pessimistic view of the outlook for Canadian interest rates.

The above pricing means thatr If Shenfeld is right in forecasting a third-quarter rate hike from the BoC, then the Canadian Dollar could experience a boost during the months ahead as investors begin to recognise that another move from the bank is not far off. 

However, Shenfeld also says that it won't be long after that until economic weakness and international uncertanties return to haunt the Canadian Dollar and force the central bank to the sideline again. He projects the USD/CAD rate will finish the 2019 year up at 1.34.

Not everybody shares the same view though, as some still hold a bullish outlook for the BoC and Canadian Dollar. The Morgan Stanley FX team is in the latter camp.  

"We remain bullish on CAD on crosses such as against NZD," says Hans Redeker, Morgan's head of FX strategy. "The Canadian labor market continues to tighten, growth momentum looks firmer with wholesale trade, business confidence, and existing home sales all printing above expectations. More robust growth coupled with firm oil prices and a tight labor market should give the BoC sufficient reason to turn more hawkish, supporting CAD."

Redeker and Morgan Stanley have advocated that clients sell the NZD/CAD rate, targeting a move down to 0.84 over the coming weeks, which is the same thing as a recommendation to buy the Loonie. They are also forecasting that the USD/CAD rate will fall to 1.28 by year-end.


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