Image © Pavel Ignatov, Adobe Stock
- The CAD retreats after retail sales figures miss market expectations.
- But CIBC economist says the numbers disguise underlying strength.
- Economy seen healthy, inflation rising and the BoC is in a tight spot.
- Scotiabank says CAD cheap, looks for losses in USD/CAD, GBP/CAD.
The Canadian Dollar ceded ground to its U.S. rival and pared gains over Pound Sterling Friday after official data showed the retail sales bonanza of March fading away at the start of the second-quarter, although economists say consumer activity was stronger than the headline figures suggested.
Canadian retail sales grew by 0.1% in April, down from a lofty and upwardly-revised 1.3% gain from March, when consensus had been for a 0.3% gain. The headline number was a miss against market expectations but a 20 basis point upward revision of the March figure smoothed things out.
Core retail sales, which ignore spending on cars because of the distorting impact their large prices have on underlying trends, also rose 0.1% but markets had looked for a 0.6% gain. This time the upward-revision of just 0.1% for the March number was not enough to smooth things over.
"After blasting ahead in March, retail sales came back down to earth in April," says Royce Mendes, an economist at CIBC Capital Markets. "That said, the weakness was relatively concentrated, with 7 of 11 categories rising in April, representing 74% of retail trade. Furthermore, even the weakness that did show up in apparel and building materials could have been due to the colder-than-usual weather, and will likely prove only transitory."
Above: Statistics Canada graph showing trend in Canadian retail sales.
Markets care about sales data because it provides insight into the likely pace of growth in a given period and momentum within an economy is an important determinant of the inflation pressures that dictate interest rate policies.
Changes in interest rates are normally only made in response to movements in inflation but impact currencies because of the push and pull influence they have over capital flows, and their allure for short-term speculators.
"The outlook for relative central bank policy is dominating and the USD is weak as market participants reassess the outlook for the Fed while also considering Wednesday’s stronger domestic CPI and the implications for the Bank of Canada," says Shaun Osborne, chief FX strategist at Scotiabank.
Above: Scotiabank graph showing USD/CAD rate and estimated fair value.
Until Wednesday, investors had bet to a modest extent the Bank of Canada (BoC) would cut interest rates before the year is out, although conviction behind those bets is now wavering after official data showed inflation surging in May.
Markets took the inflation data to mean the BoC could now be prevented from cutting its interest rate over the coming months because the bank is obliged to use monetary policy to ensure inflation averages the 2% target.
"Labour markets have remained very strong. The unemployment rate hit another new cycle-low in May. The pullback in interest rates in Canada and abroad in recent months mean that household debt payments won’t likely increase as much as has been previously feared this year or next," says Nathan Janzen, an economist at RBC Capital Markets.
Above: USD/CAD rate shown at daily intervals.
The USD/CAD rate was quoted 0.23% higher at 1.3214 following the report but is still down some 2.8% for 2019 after declining significantly throughout June as the Canadian Dollar strengthened and the U.S. greenback weakened broadly.
The Pound-to-Canadian-Dollar rate was 0.16% lower at 1.6725 following the report after rising from the 1.6673 level prevailing before publication. But this exchange rate is also down sharply in 2019, by some 3.8%.
"We think the case for additional GBP losses remains high. The downtrend in the cross is well-entrenched and should favour only limited counter trend corrections from here," says Scotiabank's Eric Theoret, a technical analyst. "We think GBP gains might retest the low/mid-1.69s but probably not too much more before renewed selling pressure emerges. We see some support at 1.6595/00 but little below here until the Feb 2017 low at 1.5744."
Above: Pound-to-Canadian-Dollar rate shown at daily intervals.
The Bank of Canada appeared to suggest in May that it could be quite some time before it lifts interest rates again, even if the domestic economic outlook has improved notably of late. It said policymakers will pay close attention to "household spending, oil markets and the global trade environment" when deciding future rate changes.
However, strong labour market data and rising inflation now mean the BoC could find it difficult to justify cutting interest rates at all and might even force it into lifting Canadian borrowing costs before long. The bank raised rates three times in 2018, leaving the cash rate at 1.75%.
"Yield spreads have narrowed considerably and oil prices are extending their recent recovery. The CAD remains fundamentally undervalued relative to our estimated equilibrium based on yield spreads and oil prices (USDCAD FV est. 1.2796). We remain medium-term CAD bulls looking to gains toward the late Feb/ early March highs," Scotiabank's Osborne adds.
"Yield spreads" represent the difference in the interest return that investors could earn from buying the government bonds of one country over another. They are an important mechanism through which central bank interest rate decisions influence capital flows and impact financial markets.
Capital flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. Rising rates have the opposite effect.
Above: U.S.-Canada two-year bond yield differential alongside USD/CAD rate (orange line, left axis).
"We still expect consumer spending growth to remain relatively unimpressive," says RBC's Janzen. "The more pressing risk to the economic outlook at the moment, though, remains for a potential escalation in the US-China trade spat to generate more significant negative spillovers to [Canada's] industrial sector."
President Donald Trump said Tuesday he will meet with his Chinese counterpart on the sidelines of the G20 conference in Osaka at month-end, stoking hopes that an imminent escalation of the U.S.-China trade war can be avoided.
Trump has been threatening to impose a 25% tariff on the remaining $300bn of China's annual exports to the U.S. if his counterpart does not agree to sign up to a deal that Chinese negotiators previously backed out of.
He already lifted from 10% to 25% the tariff charged on $200 bn of China's exports back in May, after Chinese negotiators backed away from an agreement they'd spent some five months drafting with the U.S.
A U.S.-China breakthrough, combined with a decent performance from the Canadian economy, might be enough to get the BoC lifting interest rates again later in the year if the bank's own guidance is anything to go by. But some say there are also other factors likely to be at work in the BoC's thinking.
"For the foreseeable future the BoC will have a close look at the Fed’s decisions when considering its own monetary policy. One of the reasons behind this will be trying to avoid excessive CAD appreciation against the US dollar," says Antje Praefcke, an analyst at Commerzbank.
Time to move your money? Get 3-5% more currency than your bank would offer by using the services of foreign exchange specialists at RationalFX. A specialist broker can deliver you an exchange rate closer to the real market rate, thereby saving you substantial quantities of currency. Find out more here.