Profile of the Canadian Dollar – Characteristics

In the previous article we gave you an insight into the Canadian economy, and more particularly its size, GDP compositions, exports and imports, as well as major trading partners. We also looked into Bank of Canada, its structure and goals, and the means to achieve them. Now we will turn our attention toward the Canadian dollars more specific characteristics, as well as the economic indicators with major influence on its movements.

– Commodity-based currency – the most unique characteristic of the Canadian dollar is its high positive correlation to commodity prices, almost 0.6, thus rendering it a “currency-based” commodity. As we said in the previous article, the Canadian economy relies heavily on commodity exports, especially energy. Rising commodity prices tend to benefit domestic producers, increasing their income from the exported raw materials. However, this is a double-edged sword, because an extensive jump in commodity prices will in terms reduce the physical demand from abroad, thus reducing export volumes and shrinking exporters incomes.

– Ties with the United States – we also mentioned in the previous article that the United States is the primary market for Canadian exports. The US soaks 70% of Canadas outbound shipments, while 50% of Canadas imports originate from the United States. This underscores the significant reliance the Canadian economy experiences on the state of the US economy. As the latter accelerates, it will need more raw materials, manufacturing goods and services from abroad, thus increasing imports from Canadian companies, which stimulates Canadas economy as a whole. However, this is also a two-edged sword, because as the US economy slows down or plummets into recession, trade volumes are bound to decline and the Canadian economy will suffer as well, regardless whether its public finances or banking system are stable and outperform their US counterparts.

Another factor influencing the Canadian dollar are large merger and acquisition activities, a considerable part of which involve US companies, due to the two economies proximity. M&A activity leads to significant money flows between two countries as one currency is being sold in exchange for the other, so that the foreign company conducts the necessary payments for the transaction.

– Interest rate difference – the difference between Canadas cash rates and the short-term interest rates in other developed countries are closely monitored by traders using the Canadian dollar. These differentials are indicative of potential future money flows as investors are always seeking to capitalize on higher-yielding assets. Thus, if interest rates on CAD short-term fixed income assets are higher than other foreign ones, there will be a capital inflow from that country into Canada, which implies higher demand for the Canadian dollar leading to appreciation.

Major economic indicators

Consumer Price Index – as weve already underscored in the previous article, Bank of Canadas inflation target, according to which it conducts its monetary policy, is expressed as the year-over-year increase in the Consumer Price Index, thus consumer inflation is one of the most important economic indicators for the Canadian dollar. The CPI is released by Canadas statistics department every month on both annual and monthly basis, with a delay of around 20 days after the reference month. There is also a core value of the same index, which excludes the more volatile food, energy, alcohol and tobacco costs.

Apart from the figures released by Statistics Canada, the countrys central bank publishes a separate set of Core CPI data, namely the “Bank of Canada Consumer Price Index Core”. We mentioned in our previous article that the BoC uses this set of core values to look past these temporary changes in total CPI inflation and to focus on the underlying trend of inflation. It excludes the volatile prices of fruits, vegetables, natural gas, gasoline, fuel oil, mortgage interest, intercity transportation, and tobacco. The calculations are presented on both month-on-month and year-on-year basis.

– Net change in employment – released by Statistics Canada, the employment change indicator measures the change in the number of employed people in Canada during the reference month. Gauging job creation, this indicator implies a shift in consumer sentiment and spending when significant changes are present, which in terms influences overall economic activity as consumer spending is a major driver of growth.

– Unemployment rate – the unemployment rate represents the number of unemployed Canadians as a percentage of the total labor force who have actively sought employment during the preceding month. Just like the net change in employment, it is a leading indicator and lower values, especially better-than-expected ones, strengthen the Canadian dollar amid expectations for economic growth. Both net change in employment and the unemployment rate are high-volatility indicators and are usually released within ten days after the reference month (e.g. figures for March are released within the first ten days of April).

– Gross Domestic Product – released by Statistics Canada, Gross Domestic Product growth is one of the biggest market movers. It measures the total value of goods and services produced in Canada during the reference period and is indicative for the health of the Canadian economy. In order to avoid using the same output twice in the calculation of GDP, only final goods and services are included, excluding the ones used to make another product.

Canadian GDP growth is calculated on several bases – month-on-month, quarter-on-quarter and an annualized quarter-on-quarter, and are released at the end of the second month after the reference month or quarter (e.g. the Q1 and March month-on-month readings are released in the last week of May).

– Ivey Purchasing Managers Index – prepared by the Richard Ivey School of Business and the Purchasing Management Association of Canada, this indicator provides an assessment of the business conditions in Canada. Just like other PMIs, the Ivey PMI has a threshold level of 50 which distinguishes expanding from contracting economic activity. It is released in the first week after the reference month, e.g. the reading for April is released in the first week of May. A result above 50 is logically seen as positive for the Canadian dollar, but it is not only the value that matters, but also the change from the preceding month. If the latest reading is 51, it would still be in the zone of expansion, but if the preceding months figure stood at 57, the 6-point slowdown in growth would be taken as concerning and might even have a negative effect on the Canadian dollar, thus interpretation is situational and may involve multiple-factor analysis.

– Trade balance – released by Statistics Canada, the trade balance measures the monetary difference between the countrys exports and imports of goods and services for a given period. If exports exceed imports, we have a trade surplus, while the opposite case is called a trade deficit. It covers trade in products such as commodities, manufactured goods as well as travel and transportation. Generally speaking, if a country is running a trade surplus (it is exporting more than it is importing), this means that more goods are being purchased with Canadian dollars from abroad as opposed to goods being imported against foreign currency, thus demand for the domestic currency is higher. The countrys total exports and imports, as well as the deficit or surplus they have formed, are reported between 35 and 40 days after the reference month, e.g. Januarys trade data is released within the first ten days of March.

Apart from the indicators described above, others of relatively high importance for the Canadian dollars market movements are housing data – New Housing Price Index, Housing Starts and Building Permits, as well as the Raw Materials Price Index, the Industrial Product Price Index and Canadas current account.

– Retail sales – prepared by Statistics Canada, retail sales measure the change in the total value of inflation-adjusted sales at retail stores of different types and sizes. This indicator is perceived as the main measure of consumer confidence and spending, which accounts for the largest part of economic activity. The retail sales and the core retail sales figures, which exclude the volatile automobile purchases, are released every month, with a delay of around 50 days after the reference month (e.g. the January reading is released around the 20th of March).