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8/8/2019 CAD Pulse: The Grinch That Could Steal CAD Bulls Bliss
1/6
For Required Conflicts Disclosures, please see page 5.
David WattSenior Currency StrategistRBC Dominion Securities Inc.
+1 416 842 4328
George Davis CMTChief Technical AnalystRBC Dominion Securities Inc.
+1 416 842 6633
Global FX Strategy
16 December 2010
CAD Pulse: The Grinch That Could Steal CAD Bulls Bl iss
Market Summary
Currencies Level 1 wk chg
USD/CAD 1.0071 -0.0035EUR/CAD 1.3280 -0.0100GBP/CAD 1.5675 -0.0263CAD/JPY 83.77 0.9000
USD/CAD RBC F Forwards
1M 1.0200 1.00773M 1.0100 1.00906M 0.9800 1.0114
CAD cash rates Level 1 wk chg (bp)BOC target 1.00 01m 1.20 03m 1.30 06m 1.45 112m 1.77 3
Govt bonds Yield 1 wk chg (bp)2yr 1.73 65yr 2.56 710yr 3.32 730yr 3.72 4
CA-US spread (bp) Level 1 wk chg2yr 105 05yr 60 2710yr -24 -2830yr -88 -17
Equity markets Level 1 wk chgCanada TSX comp. 13,161 -6US S&P500 1,235 2
Source: Bloomberg
USD/CAD Options
USD/CAD volatility
(%, annualised)Historical Implied
1w 2.53 8.291m 10.23 8.733m 9.92 10.176m 10.93 11.0512m 11.68 11.721m R.R 0.8c
Source: Bloomberg
USD/CAD Technicals
1.0350 Congestive resistance level
1.0140 Descending channel top1.0071 Spot
0.9977 Key quintuple bottom1.0350 Congestive resistance level
Source: Bloomberg
CAD Pulse returns on January 13, 2011. We at RBC wish all a happy and safe holidays.
FX Bottom-line: The confidence intervals around our FX forecasts remain significant and
we have identified four key risks to our 2011 bullish CAD outlook: 1) spreading European
sovereign issues; 2) a faltering US recovery; 3) a sharp downward correction in
commodity prices and; 4) stumbling Canadian consumers.
For 2011, we see USD/CAD declining toward 0.97 during the first nine months of the year
before retesting parity into year-end (spot at time of forecast: 1.01; Q3 11 Bloomberg
consensus forecast: 1.01).
We expect CAD to be one of the best performing G10 currencies during the first nine
months of 2011.
RBCs Canadian Dollar Valuations
Fundamentals Comment Impact on USD/CAD
Quarterly fair value USD/CAD is fairly valued
Weekly fair value USD/CAD is fairly valued
Canadian Economic Surprise Index -33 and is bullish USD/CAD
Canadian Data Risk Barometer Neutral USD/CAD
Market Positions and M&A Activ ity1-month, 25-delta risk reversals Neutral USD/CAD Trend M&A inflows into Canada Net outflow of US$0.2bn and is bullish USD/CAD
1. RBC more bearish than market, but numerous upside risks as 2011 approaches
0.90
1.00
1.10
1.20
1.30
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
Most bullish/bearish v iew submitted to Bloomberg
USD/CAD actual
RBC forecast
Bloomberg consensus
Upside risks to RBC's bearish
USD/CAD call:
Faltering US recovery
Increased sovereign debt concerns
Sharp commodity price correctionCanadian consumers retrenching
Source: RBC Capital Markets, Bloomberg
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16 December 2010 Global FX Strategy: CAD Pulse: The Grinch That Could Steal CAD Bulls Bliss
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Developments That Could Upset The CAD Bullish Applecartx
FX Bottom-line: Our USD/CAD call for 2011, with a cyclical
bottom around 0.97, is on the lower side of consensus.
Last week we laid out the rationale for our continued CAD
optimism. However, the confidence intervals around our
forecast remain significant and we have identified four keyrisks to our medium-term bullish CAD outlook: 1)
spreading European sovereign issues; 2) a faltering US
recovery; 3) a sharp downward correction in commodity
prices; and 4) stumbling Canadian consumers.
For 2011, we see USD/CAD declining toward 0.97 during the
first nine months of the year before retesting parity into year-
end (spot at time of forecast: 1.01; Q3 11 Bloomberg
consensus forecast: 1.01). But, as emphasized by central
bankers around the globe, uncertainty around forecasts remain
historically elevated and no forecast (bullish or bearish) would
be complete without discussing the risks around the forecast.Although obvious upside and downside risks flank our
USD/CAD forecast, we consider upside risks as more
significant with the potential magnitude impact on USD/CAD
clearly overshadowing the potential shock of downside risks.
We have identified four key risks to our medium-term bullish
CAD outlook: 1) spreading European sovereign issues, 2) a
faltering US recovery, 3) a sharp downward correction in
commodity prices and 4) stumbling Canadian consumers.
Risk 1) Spreading European sovereign issues:This weeks
European Council meeting is unlikely to end with a definite and
detailed agreement amongst EU nations regarding theexpansion of the European Financial Stability Facility (EFSF),
E-bonds or a long-term solution to the current
sovereign/banking problems faced by many Eurozone
members. The lack of clear direction could render the fiscally
challenged EZ-members particularly vulnerable in early 2011
as a heavy European government bonds issuance season
unfolds for a detailed discussion see last weeks European
Directions. Our European strategists see Portugal succumbing
to the same fate as Ireland and Greece. Spain, on the other
hand, might be able to avoid a formal bailout, albeit barely. If
our Spanish call is wrong and Spanish spreads continue towiden to the point where PM Zapateros hand is forced and he
requests financial assistance, a new wave of European
sovereign concerns will likely emerge, weighing not only on
peripheral Europe but also on core Europe as the fourth largest
EZ member turns from contributor to the EFSF to the probably
the biggest recipient. Global risk sentiment and
commodity/cyclical currencies, including CAD, will likely
become collateral damage and safe havens USD and JPY the
beneficiaries. We consider this a critical risk to our USD/CAD
call.
Risk 2) Faltering US recovery: The double-barrelledapproach by US authorities - QEII and an extension/expansion
of fiscal measures - has greatly reduced the probability of a
sluggish economic recovery during the early part of 2011. We
have downgraded the risk of a sluggish recovery in H1 2011
from critical to low and for H2 from critical to moderate.
However, with economic growth expectations increasingly
driving markets, doubts about the ability of the private sector to
eventually take over the growth baton could easily turn intooutright pessimism, similar to Q3 2010. An unemployment rate
hugging 10% rather than the expected gradual improvement, a
continuation of low consumer confidence and another wave of
housing weakness driven by shadow inventory, foreclosures
and distressed sales could fuel this pessimism. These
developments will affect global sentiment and the timing of the
expected normalization campaign by the BoC, possibly
resulting in a repeat of the perverse USD-economic data
relationship when disappointing US data resulted in a renewed
flight to safe haven assets, boasting USTs, USD and JPY.
CAD will be particularly vulnerable against the crosses if this
risk materialises.
2. US-Can spreads expected to narrow further
0.90
1.00
1.10
1.20
1.30
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
-1.7
-1.2
-0.7
-0.2
0.3
0.8
1.3
USD/CAD, LHS
US-Can 2yr swap spread, RHS
Source: RBC Capital Markets, Bloomberg
Risk 3) Commodity price correction:The V-shaped recovery
in emerging markets has pushed commodity prices close to or
past their 2008 highs, with most commodity prices currently
trading at historically elevated but not necessarily unjustifiable
levels as long as emerging market growth continues. Our EM
team sees overall EM growth moderating from 6.7% in 2010 to a
more sustainable 5.8% in 2011, enough to keep commodity
prices around current levels, but insufficient to generate further
upward momentum. However, an under-appreciation of the
adverse impact on EM growth from slowing cross-border trade
and tighter monetary policy by EM central banks could lead to a
sharp sell-off in commodity prices if reality starts undershooting
EM growth expectations. We consider this a moderate risk, but if
this risk plays out, the impact on USD/CAD could be severe with
a rally back to 1.10 quite conceivable.
Risk 4) Stumbling Canadian consumers: Unlike US
households post the 2008 credit fallout, Canadian households
continue to augment their purchases through borrowing. Since
the credit crisis, Canadian household debt has increased by 18%
continued on next page
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Global FX Strategy: CAD Pulse: The Grinch That Could Steal CAD Bulls Bliss 16 December 2010
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4. Close tie between commodity prices and CAD
200
400
600
800
97 98 99 00 01 02 03 04 05 06 07 08 09 10
0.60
0.80
1.00
1.20
1.40
1.60
BoC Commodity Price Index, LHS
USD/CAD, inverted, RHS
Source: RBC Capital Markets, Bloomberg
5. Sharp divergence between US and Canadian debt trends
while US household credit declined by 2% over the same period.
In Q3 2010 household debt in Canada, as a percentage of
personal disposable income, surpassed the US ratio and almost
150% the BoC and Canadian government are justified in
sounding the warning bells. As noted in the latest (Dec)
Financial System Review, developments since the June FSR
suggest that the vulnerability of the Canadian household sector
has increased Without a significant change in behaviour, the
proportion of households that would be susceptible to serious
financial stress from an adverse shock will continue to grow.
The probability of an adverse labour market shock materializing
is judged to have edged higher in recent months Also see
Global Directions for a more in depth discussion of Canadian
household debt issues. Thus, while it is unlikely that the
Canadian recovery will stall amid strong EM growth and a
decent recovery in the US, a growth slowdown in EM Asia (via
commodities) or a faltering US economy could accentuate the
vulnerability of Canadian household balance sheets, potentially
necessitating a painful deleveraging at a time when the
Canadian recovery is not yet fully entrenched. Although non-
negligible, this risk is viewed as the least likely of the four risks
to come to fruition, but could exacerbate the adverse impact on
CAD as other risk scenarios unfolds.
CAD Pulse, 9 December, US Stimulus a Balm to CAD Strengths Sting, anGlobal Directions, 9 December, 2011 Outlook. As well, the Currency ReportCard, 15 December, 2011 Outlook. European Directions 8 December, Supply Outlook Q1 2011. Also see the Canadian section of Global Directions, 16 December. 75
100
125
150
175
Mar-90 Mar-94 Mar-98 Mar-02 Mar-06 Mar-10
USA
Canada
Household debt as % of
personable disposable
income
Source: RBC Capital Markets, Haver Analytics
Quintuple bottom at 0.9977 remains untested 6. USD/CAD: Trading range persists
Bearish price action has remained prevalent in USD/CAD as
prices remain mired near the bottom of the 0.9977-1.0679
trading range that has been in place since June. Our core
technical view is that bearish sentiment will persist as long as
prices remain below the key congestive resistance area at
1.0350 on a daily closing basis. The 200-day moving average at
1.0273 has also aided in limiting the upside since September.
We continue to stress that the key quintuple bottom at 0.9977
must give way in order to produce a new bearish phase for
USD/CAD and expose the 2010 low at 0.9931, followed by along-term support level at 0.9713 thereafter. Topside resistance
at 1.0140 and 1.0215 is expected to attract selling interest.
Source: RBC Capital Markets, Tradermade
Data Risk: Neutral USD/CAD
Dec Data/Event RBC Mkt Pre Risk *
20 Oct Wholesale Sales m/m 0.4%
21 Nov Consumer Price Index 2.4% (0.4%)
21 Nov Core CPI 1.8% (0.4%)
21 Oct Retail Sales (less auto) 0.6% (0.4%)Source: RBC Capital Markets, Bloomberg
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16 December 2010 Global FX Strategy: CAD Pulse: The Grinch That Could Steal CAD Bulls Bliss
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RBC Capital Markets Fixed Income & Currency Strategy
RBC Capital Markets, LLC:
Stevyn Schutzman Global Head of FIC Strategy &
Research and Chief Macro Strategist
(212) 618-2553 [email protected]
Europe
Royal Bank of Canada Europe Limited:
James Ashley Senior European Economist +44-20-7029-0133 [email protected]
Norbert Aul European RatesStrategist +44-20-7029-0122 [email protected]
Gustavo Bagattini European Economist +44-20-7029 0147 [email protected]
Adam Cole Global Head of FX Strategy +44-20-7029-7078 [email protected]
Sam Hill UK Fixed Income Strategist +44-20-7029-0092 [email protected]
Jens Larsen Chief European Economist +44-20-7029-0112 [email protected]
Christian Lawrence Fixed Income Strategist +44-20-7029-7085 [email protected]
Elsa Lignos G10 Currency Strategist +44-20-7029-7077 [email protected]
Peter Schaffrik Head of European Rates Strategy +44-20-7029-7076 [email protected]
Asia-Pacific
Royal Bank of Canada Sydney Branch:
Su-Lin Ong Head of Australian andNew Zealand FIC Strategy +612-9033-3088 [email protected]
Michael Turner Fixed Income & Currency Strategist +612-9033-3088 [email protected]
Royal Bank of Canada Hong Kong Branch:
Sue Trinh Senior Currency Strategist +852-2848-5135 [email protected]
North America
RBC Dominion Securities Inc.:
Mark Chandler Head of Canadian FIC Strategy (416) 842-6388 [email protected]
David Watt Senior Currency Strategist (416) 842-4328 [email protected]
Kam Bath Fixed Income Strategist (416) 842-6362 [email protected]
George Davis Chief Technical Analyst (416) 842-6633 [email protected]
Paul Borean Associate (416) 842-2809 [email protected]
RBC Capital Markets, LLC:
Michael Cloherty Head of US Rates Strategy (212) 437-2480 [email protected]
Tom Porcelli Chief US Economist (212) 618-7788 tom.porcelli @rbccm.com
Jacob Oubina Senior US Economist (212) 618-7795 [email protected]
Keith Blackwell Associate Rates Strategist (212) 858-6077 [email protected]
Chris Mauro Head of US Municipals Strategy (212) 618-7729 [email protected]
Dan Grubert Associate (212) 618-7764 [email protected]
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Global FX Strategy: CAD Pulse: The Grinch That Could Steal CAD Bulls Bliss 16 December 2010
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Required Disclosures
Conflicts Disclosures
The analyst(s) responsible for preparing this research report received compensation that is based upon various factors, including
total revenues of the member companies of RBC Capital Markets and its affiliates, a portion of which are or have been generated
by investment banking activities of the member companies of RBC Capital Markets and its affiliates.
Conflicts Policy
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To access our current policy, clients should refer to https://www.rbccm.com/global/file-414164.pdf or send a request to RBC CM
Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. We
reserve the right to amend or supplement this policy at any time.
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