Chief Investment Officer at Asas Capital Matein Khalid comments on the price, progress, and future of the Canadian dollar and Indian rupee.
I had recommended investors buy the Canadian dollar at 1.3450 for a 1.30 – 1.31 strategic target on May 13, 2019. The Canadian dollar trades at 1.3060 now, having risen against the US dollar in ten of the past eleven trading sessions. Strong April GDP growth data, coupled with robust job creation and a 10% rise in West Texas Intermediate crude in June means the Bank of Canada has no need to cut interest rates at a time when the Powell Fed could well slash the Fed Funds rate by 50 basis points at the July and September FOMC conclaves.
So it was no surprise to me that the loonie surged 2.3% in June, the best performer in the G-10 foreign exchange league tables against the greenback. While I wanted my strategic 1.31 target to be conservative and doable, I now believe the Canadian dollars uptrend can extend to 1.28 against the US dollar in the second half of 2019. For now, my risk-reward calculus tells me to book profits – a better entry point than 1.31 for new money loonie bulls will surely emerge in July.
One catalyst for the rise in the loonie was the explosion in the Philadelphia refining complex earlier this month. This shutdown is significant because it both boosted oil prices but also created demand for Canadian petroleum exports to the US since the Philly refining complex is the largest on the US East Coast/Mid-Atlantic seaboard. The escalation of geopolitical risk in the Gulf also boosted Brent and the loonie.
The collapse of US-Canada interest rate differentials, risk appetites on Bay Street, expectations of Fed, ECB, Bank of Japan and even China PBOC monetary easing and the technical bearishness in the US Dollar Index all signal additional Canadian dollar strength to me.
All is, of course, not hunky dory in this best of all possible Panglossian worlds for the loonie. There is a global oil glut and West Texas crude is still vulnerable to any breakdown in OPEC production cut discipline, new slumps in Chinese petroleum demand and the surge in US shale oil output above 12 MBD. The Canadian Market PMI at 49 was a tad soft relative to jobs/growth data. Any U-turn on US monetary policy by Chairman Powell could mean a rise in the US/Canada two year yield spread, as welcome to the loonie as a cross of gold in sunlight is to Count Dracula. Global equities could get spooked by tensions in the Gulf or China and boost the Volatility Index. Such events will enable us to position for another fabulously profitable loonie strategic idea. But that is then and this is now.
For now, the Bank of Canada will keep its 1.75% base rate unchanged even as Wall Street expects the Powell Fed to move at the July and September FOMC. After all, the Ottawa Central Bank’s preferred measures of inflation are above 2% while the Fed’s beloved core PCE is well below its 2% target at 1.60%. These are the variables that determine short term interest rates – and these signal fresh capital flows in to the loonie!
Chicago Fed Fund futures have now priced in a near certain July FOMC rate cut. This means there could be an asymmetric response whether the FOMC cuts rates or not, a sell-off in the frothy stock market, a rise in the Volatility Index and lower global currencies. When a sure thing Fed put is priced into the money markets, it is time to position for a contrarian trade relative to my fair value model.
I believe the Indian rupee is undervalued at 69.25 against the US dollar. True, US-China trade tensions, a sharp deceleration in Indian GDP growth and the snapback in crude oil prices have all taken their toll on the Indian rupee, despite the euphoria of the BJP landslide win in the 2019 general election. The past decade has been a disaster for investors who were long unhedged Indian rupees, which means most NRI’s in the Gulf. I remember the Indian rupee traded at 42 against the US dollar when Lehman Brothers failed in mid-September 2008 and traded as low as 74 to the US dollar during the Halloween risk spasm in global equities in late October 2018.
Yet the sheer scale of Modi’s win makes a stimulative 2019 Union Budget unlikely, an event that will disappoint Dalal Street. In a world with $12 trillion in government bonds trading at negative yields, the ten year Indian G-Sec note at 7.4% offers stellar value and at least an attractive 3.5% real interest rate. True, the current Reserve Bank of India (RBI) governor is not Dr. Raghuram Rajan or Dr. Urijit Patel but a finance Ministry apparatchik/babuji who will succumb to BJP pressures to cut interest rates.
Historically, Indian governments that just won an election opted for fiscal prudence since there was no longer any need to appease their vote banks with handouts. The Indian rupee will thus gain from a perception that New Delhi will focus on reducing its fiscal deficit. I also expect Gulf geopolitical tensions to ease as neither Washington nor Tehran wants a new war. This means lower crude oil prices, positive for the Indian current account deficit and the rupee.
India’s nonbank finance system’s stress has contributed to a fall in economic growth, state spending and infrastructure loan growth. Net net, New Delhi will pressure the RBI to goose economic growth via more accommodative monetary policy. As US Treasury note yields tank and the Uncle Sam budget deficit rises to 4.8% of GDP. I expect the Indian rupee to rise to 65 against the US dollar – ceteris paribus (even though all other things are never equal!).
The caveat here is that the Indian shadow banking crisis becomes virulent and systemic, global investors flee Bharat Mata in panic and the stock market crashes – in that case, the RBI could slash the repo rate to 2% in order to engineer negative real rates and the rupee could go for a full toss against the dollar down to 80 – 85. Who said it was easy to make money on Planet Forex or in a financial passage to Modi’s India? So options will remain the jewel in my macro crown, just as India itself was once the jewel in Britannia’s crown.