Canadian Dollar Slips as Economy Sheds Jobs and Trudeau-Trump Spat Weighs

-CAD labour market sheds jobs for second month running in May.

-Trade fears rise following Trudeau-Trump spat ahead of G7 meeting. 

-Trade fears and BoC interest rate risks to continue weighing on CAD.

© COSPV, Adobe Stock

The Canadian Dollar weakened against many of its developed world rivals Friday as traders responded to a disappointing set of jobs numbers for May, while also responding to a developing trade spat between Prime Minister Justin Trudeau and US President Donald Trump.

Canada's economy created shed 7,500 jobs during the recent month, extending a slump that began with a 1,100 contraction in April, which was far below the consensus for jobs growth of 19,100 in May. The unemployment rate held steady at 5.8%, in line with market expectations. 

"April showers didn't bring May flowers for the Canadian labour market," says Royce Mendes, an economist at CIBC Capital Markets. "The economy lost 31k full-time jobs, and the participation rate declined one tick to 65.3%. The drop in participation was the only reason the unemployment rate remained steady at an historically low 5.8%."

Markets care about jobs data because falling unemployment can have a significant impact on demand and growth within an economy. This means it can also exert influence over inflation and so is pertinent to questions around interest rates, which are themselves the raison d'être for most moves in exchange rates.

"Overall, this is the second negative reading on the economy today, after housing starts also undershot expectations," Mendes adds. "At this point, it's still too early to say this will alter the Bank of Canada's thought process surrounding a July rate hike. But, a few more readings like this and the Bank could begin to reconsider the timing of the next hike."

Traders are currently looking to the July Bank of Canada meeting for its next rate hike, with interest rate derivative market pricing implying a near 80% probability the BoC will raise its cash rate to 1.5% on July 11. This implied probability, along with the Canadian Dollar, will be sensitive to the unemployment numbers Friday.

"Small disappointment in job gains should add modest downside pressure to CAD despite wages expected to remain stable as a priced BoC and lingering trade tensions keep CAD's return profile asymmetrically tilted lower as Poloz's newfound optimism may begin to look misplaced," says Fred Demers, chief Canada macro strategist at TD Securities. "1.2900 and 1.2850 offer good levels to buy dips. 1.30 remains an anchor for USDCAD with 1.3040/50 a key resistance marker."

The USD/CAD rate was quoted 0.18% higher at 1.3020 following the release Friday while the Pound-to-Canadian-Dollar rate was 0.02% higher at 1.7421. The Canadian Dollar was also lower against the Japanese Yen and New Zealand Dollar, but higher relative to the Euro, Swiss Franc and Australian Dollar.

"Trade uncertainties are countering positive fundamentals that should be on show today with a strong jobs report from Canada expected," says Derek Halpenny, European head of global markets research at MUFG. The G7 leaders’ summit is taking place in Quebec today and tomorrow and Prime Minister Trudeau is unlikely to hold back in criticising President Trump. Fears also continue to mount over a collapse of NAFTA."

Halpenny flags the high probability of a July rate hike that is currently baked into financial market pricing of Canadian assets and warns that this, and the current geopolitical environment, leave the Loonie vulnerable to a set-back. A set-back could come either as a result of poor jobs data or a further escalation of concerns over the outlook for international trade.

President Donald Trump's combative approach toward nations with which the US has a perceived unfair trade relationship has placed markets on edge in recent months, particularly after the White House targeted China, the EU, Canada and Mexico with a series of tariffs that have prompted fears of a so called trade war.

Friday and Saturday will see national leaders from the so called group of G7 nations meet to discuss a range of issues, although international trade is expected to feature heavily on the agenda. Already, Canadian Prime Minister Justin Trudeau and French President Emmanuel Macron have made a number of barbed remarks at a press conference ahead of the summit, drawing an angry rebuke from President Trump on Twitter.

This sent markets into a "risk off" mood Friday, which saw the US Dollar rise broadly and risk currencies like the Australian and Canadian Dollars fall. It also comes hard on the heels of a series of other developments that have all called the future of the North American Free Trade Agreement into question. 

White House economic adviser Larry Kudlow told Fox & Friends Tuesday that President Donald Trump is contemplating separate negotiations with Canada and Mexico, rather than the current format where the US sits with both other parties. Kudlow's comments came hard on the heels of more telling remarks by President Trump himself on Friday.

"I wouldn't mind seeing a NAFTA where you go by a different name, where you make a separate deal with Canada and a separate deal with Mexico. Because you're talking about a very different two countries," President Trump told reporters last week, hinting at replacing the current NAFTA deal with two separate bilateral agreements.

The NAFTA stakes are high for the Loonie because some analysts have estimated the currency could fall as much as 20% if the White House goes for the nuclear option and announces a US withdrawal from the agreement. This would set the clock ticking on a six month termination period.

“Market rate hike expectations in Canada would fall but not fully price out tightening and price in termination,” writes Brittany Baumann, another FX strategist at TD Securities, in a January note. “Wider rate spreads would drive CAD to weaken by 8-10% based on the elasticity in our fair value model.”

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