Profile of the Canadian dollar – characteristics and major economic indicators
You will learn about the following concepts
- Characteristics of the Canadian dollar
- Major economic events
In the previous article we gave you an insight into the Canadian economy, and more particularly its size, GDP composition, exports and imports, as well as major trading partners. We also looked into the Bank of Canada, its structure and goals, and the means to achieve them. Now we will turn our attention towards the Canadian dollar’s more specific characteristics, as well as the economic indicators with a major influence on its movements.
– Commodity-based currency – the most distinctive characteristic of the Canadian dollar is its strong positive correlation of almost 0.6 with commodity prices, thus rendering it a ‘commodity-based’ currency. 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 exported raw materials. However, this is a double-edged sword, because a sharp jump in commodity prices will, in turn, reduce physical demand from abroad, thus reducing export volumes and shrinking exporters’ incomes.
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– 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 absorbs 70% of Canada’s outbound shipments, while 50% of Canada’s imports originate from the United States. This underscores the significant reliance the Canadian economy has on the state of the US economy. As the latter accelerates, it will need more raw materials, manufactured goods and services from abroad, thus increasing imports from Canadian companies, which stimulates Canada’s economy as a whole. However, this is also a double-edged sword, because if the US economy slows down or plunges into recession, trade volumes are bound to decline and the Canadian economy will suffer as well, regardless of whether its public finances or banking system are stable and outperform their US counterparts.
Another factor influencing the Canadian dollar is large merger and acquisition (M&A) activity, a considerable part of which involves US companies due to the two economies’ proximity. M&A activity leads to significant money flows between the two countries as one currency is sold in exchange for the other, enabling the foreign company to make the necessary payments for the transaction.
– Interest rate differential – the difference between Canada’s cash rate and short-term interest rates in other developed countries is closely monitored by traders dealing in the Canadian dollar. These differentials are indicative of potential future money flows, as investors are always seeking to capitalise on higher-yielding assets. Thus, if interest rates on CAD-denominated short-term fixed-income assets are higher than those abroad, there will be a capital inflow into Canada, which implies higher demand for the Canadian dollar, leading to appreciation.
Major economic indicators
Consumer Price Index – as we’ve already underscored in the previous article, the Bank of Canada’s inflation target, according to which it conducts monetary policy, is expressed as the year-over-year increase in the Consumer Price Index. Consequently, consumer inflation is one of the most important economic indicators for the Canadian dollar. The CPI is released by Canada’s statistics department every month on both an annual and a 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 country’s 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 temporary changes in total CPI inflation and to focus on the underlying trend of inflation. It excludes the volatile prices of fruit, vegetables, natural gas, petrol, fuel oil, mortgage interest, intercity transportation and tobacco. The calculations are presented on both a month-on-month and a year-on-year basis.
– Net change in employment – released by Statistics Canada, the employment change indicator measures the variation 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 turn 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 labour force who have actively sought employment during the preceding month. 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 the 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 of the health of the Canadian economy. To avoid counting the same output twice in the calculation of GDP, only final goods and services are included, excluding those used to make another product.
Canadian GDP growth is calculated on several bases – month-on-month, quarter-on-quarter and annualised quarter-on-quarter – and is 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 business conditions in Canada. Just like other PMIs, the Ivey PMI has a threshold level of 50 that distinguishes expanding from contracting economic activity. It is released in the first week after the reference month; for example, 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 month’s figure stood at 57, the six-point slowdown in growth would be regarded as concerning and might even have a negative effect on the Canadian dollar. Interpretation is therefore situational and may involve multi-factor analysis.
– Trade balance – released by Statistics Canada, the trade balance measures the monetary difference between the country’s exports and imports of goods and services for a given period. If exports exceed imports, there is 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 in exchange for foreign currency, thus demand for the domestic currency is higher. The country’s 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; for example, January’s 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 dollar’s 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 Canada’s 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 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 20 March).