By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
I was stunned by the Canadian jobs data on Friday. The economy added a record 106,500 workers in April across a broad spectrum of industries/provinces while wage growth was a stellar 2.5%. This is beyond good – it is great news and totally destroys the “Great White Short” investment thesis of some big macro funds in Greenwich, Manhattan and London (you know who you are, O leveraged Masters of the Universe!).
To paraphrase the lament of Mexican dictator Porforio Diaz “Poor Canada. So far from God, so close to the United States”. The April jobs and wages data are a game changer for my tactical outlook on the loonie. I now believe the Canadian dollar is a compelling buy at 1.3450 for a 1.30 three-month target. Why?
One, the Canadian economy is far stronger than the soft patch presented by Bank of Canada Governor Stephen Poloz at the last Monetary Policy Review. Such strong job/wage growth is inconsistent with the Great White Short thesis that the Canadian housing price time bomb is set for imminent detonation. This means Governor Poloz has no need to signal a rate cut to Bay Street – au contraire. If there is no recession risk in Canada, there is no need for a preemptive rate cut by the Ottawa central bank. Quite the opposite, in fact.
Two, geopolitical tensions in Venezuela, Libya, US-Iran and Algeria are rising alarmingly. This means crude oil prices (energy is 25% of the Canadian GDP), can tighten well above $70 Brent. The loonie is a de facto petrocurrency in North America.
Three, Chicago Merc IMM data suggests that the entire Milky Way is a speculative short on Canadian dollar. This could mean the mother of all short squeezes next week. The loonie can soar like an eagle as the shorts get squeezed by real money accounts.
Four, as the Daddy of a McGill University senior and friend of so many Dubai based “snow birds”, the loonie’s twists and turns are part and parcel of my trading life. Yet I notice the the shrinkage in interest rate differentials between two year US Treasury notes and Canadian government debt, historically correlated with short term loonie moves, suggests the Canadian dollar is undervalued relative to economic performance and interest rate spreads with Uncle Sam’s IOU’s. This means the Canadian dollar is now once again a tactical buy at 1.3450 for a 1.30 target with a trailing stop loss.
Five, it is mission critical that loonie bears cover their shorts and reappraise Justin Trudeau’s track record as Canada’s Liberal Prime Minister. After all, the Canadian economy has added 700,000 jobs in the past two years and the unemployment rate, while 5.7% or 201 basis points above its US equivalent, is still the lowest since the Brian Mulroney era almost four decades ago.
Six, King Dollar can be hit by US-China trade backlash, safe haven buying in US Treasuries and soft inflation data that could deter the Powell Fed from a 2019 rate hike. The two-year US Treasury note premium to Canadian government debt has compressed from 70 to 62 basis points as I write. West Texas crude is $62. In my valuation crystal ball, this is consistent with a 1.30 loonie. So there!
A potential breakdown in US-China trade relations will have a seismic impact on international financial markets. After all, the Middle Kingdom is at the epicenter of global supply chains in industries that range from semiconductors to handsets, computer components to home/hotel furniture. Moreover, Chinese corporates have borrowed $850 billion in onshore Asian debt/syndicated loan markets. There is thus a panic bid in the US dollar against the Chinese yuan. It is entirely possible that the Chinese yuan depreciates to 7.50 if trade tensions escalate into a new economic Cold War between Washington and Beijing.
The petrocurrency trade de jour seems to be to go long the Russian rouble against the Mexican peso. This does not surprise me. The volatility adjusted carry metrics in the Russian rouble have meant a 9% return against King Dollar in 2019. In fact, hedge funds are increasing their exposure on the Russian rouble at 65 on the conviction that oil prices will be anchored by geopolitical risk in the Middle East and Russian economic growth could accelerate once Bank Rossiya cuts policy rates.
The 57.30% weak ANC win in the South African general election reflects the toxic political legacy of the Zuma “lost decade”. Yet the financial markets believe Ramaposa’s majority is a de facto mandate for economic reform, the reason the Rand rose to 14.19 after the polls. Of course, a major rand rally needs a US-China trade pact, a dethroned King Dollar and frontloaded ANC embrace of reforms. My pessimism on this macro scenario leads me to believe the Azania Rand is headed to 14.60 by year end 2019. Watch King Dingan do the Juju on Ramaposa’s new Cabinet.