Canadian Dollar 2023 Price Outlook (CAD) - Housing Market Vulnerability is an Emerging Theme
00:21, 14 December 2022
Canadian Dollar 2023 Outlook
Much like the majority of USD pairs, the Canadian Dollar struggled against the greenback throughout 2022 with the currency slipping as much as 7% at the time of writing. What’s more, a sell-off in Q4 saw the Loonie notably underperform on the crosses, making the currency one of the worst performers in the G10 in 2022. It is also worth noting that the underperformance in the Loonie across the board is in part due to being low-beta to the USD, which peaked in Q4. This somewhat contrasts with the reflation trade optimism that market participants had hoped for heading into 2022.
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The Canadian Dollar’s 2022 year in review
Canadian Dollar 2022 Performance - Photo: Capital.com. Source: TradingviewCanadian Dollar’s Waning Correlation with Oil in 2022
What was also made apparent throughout 2022 had been the diminished correlation between oil prices and the energy-sensitive Canadian Dollar. This could be partly explained by the fact that a geopolitical risk premium attached to the Russia/Ukraine war had kept oil prices afloat. Meanwhile, a bear market amid central banks aggressively raising interest rates prompted currencies such as the Canadian Dollar to come under pressure, despite firmer oil prices. Keep in mind that firmer oil prices had largely stemmed from supply constraints, coupled with geopolitical tensions for the majority of 2022, not rising economic growth and subsequent demand growth.
90-Day Correlation: Canadian Dollar vs Brent Crude Oil
Canadian Dollar vs Oil Correlation - Photo: Capital.com. Source: TradingviewBank of Canada Ready to Hit the Pause Button
In its final rate decision of the year, the Bank of Canada hiked the key interest rate by 50bps to 4.25%. However, the bank altered its forward guidance by adding that they would “consider” whether rates would need to rise further. As such, as we look to Q1 of next year, the BoC are likely to pause rate hikes. This shift in language from the governing council has prompted money markets to be most dovish on the BoC relative to its counterparts with only a 40% probability for a 25bps hike at the January meeting. To me, this could provide support for the Canadian Dollar relative to currencies where money markets remain far too aggressive on the rate outlook (GBP and NZD). With the BoC now hinting at becoming much more data-dependent, firm inflation/jobs data in the lead-up to the January meeting may well underpin the Loonie. Although, I would pair this against the aforementioned currencies where the risk of a hawkish disappointment is high.
Canadian Interest Rates vs Inflation
Canadian Rates vs Inflation - Photo: Capital.com. Source: TradingviewCanada’s Housing is a Key 2023 Theme
A theme for 2023 will be, what will happen to the housing market following an aggressive tightening cycle. Canada’s economy is much more sensitive to rising rates than in the past given the highly levered housing sector. Alongside this, elevated borrowing will correspond with rising debt servicing costs, while the uptake in variable mortgages, which now account for one-third of total outstanding mortgage debt could raise the economic hardship on consumers next year as rates are reset at much higher rates. The risk is that trigger rates are reached, which are explained in more detail in this Bank of Canada staff working paper. Consequently, housing market vulnerabilities provide a red flag for the Canadian Dollar as the BoC’s rate hikes feed their way into the economy.
Will China’s reopening provide relief for CAD/Oil?
As we close out the year, among the biggest shifts in sentiment has been on China. With the bias heavily skewed on the negative side, China’s reopening efforts have prompted a 180 sentiment shift with market participants now growing notably bullish in the region. What is important to note is that this narrative has taken away one key pillar of support for the US dollar, which in turn has allowed for USD/CAD to drift. However, a red flag has been regarding the oil market, which has not necessarily felt this wave of optimism regarding China opening up. At the time of writing, oil prices are around flat for 2022, which is despite, OPEC cuts, a war in Europe and the Q4 USD sell-off. As such, this does make me somewhat cautious about oil prices heading into 2023 and by extension the Canadian Dollar, while I have mentioned above the correlation between CAD & oil has diminished, falling oil prices will still be a headwind for the currency.
Recession Alarm Bells
While it is possible for the Canadian Dollar to benefit from a window of USD softness as the momentum of US inflation tilts to the downside. With the recession bells ringing loudly, it is difficult to be entirely enthusiastic about risk-sensitive currencies such as the Loonie. The read across among market participants is that there will be a mild recession, meaning that markets have yet to price in no recession or a severe recession. Given that yield curve inversion signals have had a 100% strike rate over the last 50-60 years it is hard for me to go against the view that there will be a recession at some point, the difficulty of course is the time lag between signal and actual recession. Nonetheless, the recession play would likely be via lower CAD/JPY while the Yen could also benefit from rising expectations that the Bank of Japan may look to exit from its dovish stance once Governor Kuroda’s term ends in April 2023.
USD/CAD Technical Outlook
Despite the Canadian Dollar’s underwhelming performance during a period of US dollar softness, there is still a risk of a move towards 1.30-1.32 as softer US inflation prompts a greater unwind of USD longs. However, a sustained move sub-1.30 appears unlikely to me and as the BoC begin to fret about the potential housing market vulnerabilities risks are geared to the higher 1.30s heading into the end of Q1.
USD/CAD chart: daily time frame
USD/CAD Chart - Photo: Capital.com. Source: TradingviewRelated topics
