Canadian Dollar the Next Big Short for Spectra Markets as Mortgages Eyed

"In Canada, ironically, when rates were super, super crazy low in 2020 and 2021 - so the point when rates were the lowest and when most housing activity was happening - more people went to variable than ever before, which is the worst possible time," Spectra Markets 

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The Canadian Dollar has been an outperformer for much of the year but has recently begun to lag behind many other major currencies and  for Spectra Markets it's quickly becoming a prime candidate for speculative short-selling ahead of an anticipated economic slowdown driven by rising mortgage rates.

Canada's Dollar had slipped from second to third in the pecking order of G10 currency performances for the year by Friday after sustaining sizable losses against all major counterparts except for the U.S. Dollar, which has corrected lower across the board over the course of November.

This has seen the year's two top performing currencies, the Loonie and greenback, scraping the bottom of the bucket in recent trade and for Spectra Markets it likely marks the beginning of a lengthy trend reversal that is expected to see the Canadian currency remain an underperformer in the months ahead.

The big idea is a sharp increase in Bank of Canada (BoC) interest rates this year will eventually filter through to monthly mortgage payments in Canada where higher borrowing costs are expected to eat into household incomes, leading to adverse second round effects on various parts of the economy.

"So for example a friend of mine in the UK is paying £1,500 right now and his mortgage is going to reset to £5,500 and that's not an outlier. He got his mortgage when the base rate was negative and now the base rate is going to be 3% or 4% or whatever. So that will start to happen in Canada as well," says Brent Donnelly, CEO at Spectra Markets and a veteran currency trader with time spent at hedge funds and banks including Lehman Brothers and HSBC

"In Canada, ironically, when rates were super, super crazy low in 2020 and 2021 - so the point when rates were the lowest and when most housing activity was happening - more people went to variable than ever before, which is the worst possible time, because the spread from variable to fixed widened," Donnelly said in a Monday podcast.

Donnelly cites residential investment in housing that runs to almost 10% of GDP annually for thinking that Canada's economy will be among those bitten hardest by this year's increases in interest rates, which is in turn an important part of why the Canadian Dollar now appeals as a candidate for spelative selling. 

The idea is this should leave the Loonie well placed to underperform currencies of economies that are not as reliant upon housing and the surrounding industries, which is a part of why Donnelly has advocated selling the Canadian Dollar and buying the New Zealand Dollar instead. 

"Canada is at risk of severe pain from mortgage resets and housing pain. Canada’s exposure to residential fixed investment is huge (around double the US exposure, see blue line at right). Meanwhile, Canadians are exposed to significant mortgage reset risk as the popularity of variable rate mortgages ROSE at the lows in rates," he says.

Source: Spectra Markets.

"China reopening will benefit NZ as they are a major exporter of consumption goods, especially dairy and soft commodities. If we get a bullish China story in 2023, it’s going to be on the back of consumption, not capex. And Chinese tourism to New Zealand is an important flow of cash," Donnelly wrote in a Monday market commentary. 

While the Loonie has frequently ranked among the top performing currencies of the year, the New Zealand Dollar has struggled and at times it has underperformed many other currencies, seemingly due to the Kiwi's exposure to a Chinese economy that has remained burdened by coronavirus-related restrictions on activity.

But with speculation about an early 2023 reopening growing in recent weeks, the China trade relationship could turn from headwind to tailwind next year, with positive implications for the New Zealand Dollar throughout the period in which the Canadian Dollar is expected to feature as an underperformer.

"The entry point is annoying here because NZDCAD has rallied 5% in a straight line since that video was recorded," Donnelly says in Monday's AM/FX. 

"If you’re thinking on a 6-month or 12-month time horizon, it’s fine. The 2022 high of 0.8800 is a good target for a 6-month view with 0.9200 more ambitious. If you’re patient and would prefer to buy a dip, 0.8000 is the support now," he said in reference to NZD/CAD, which has a positive correlation with GBP/CAD. 

Above: NZD/CAD shown at daily intervals alongside GBP/CAD (blue).