LOONIE’S REBOUND MAY NOT BE DONE DESPITE ANXIETY

‘Crash and burn’ narrative was overdone, if not spurious, writes David Rosenberg.

The Canadian dollar, just a short two months ago at the height of the Home Capital debacle, was trading near $1.38 per U.S. dollar and the widespread consensus view at the time was that this was the proverbial canary in the coal mine for the rest of the banking sector, with a possible spillover effect to housing and the economy. The bearishness on the currency, economy and the banks were palpable.

Yet, somehow, the Canadian economy has emerged as the strongest in the G7, the banks stocks have rebounded four per cent with all but one of the Big Five smashing through their latest quarterly EPS estimates, and the loonie has bounced up very sharply. Warren Buffett clearly was on to something, and now so is the Bank of Canada, as it braces the markets for a near-term rate hike — the first in seven years.

The “crash and burn” narrative on Canadian housing, consumer balance sheets, the banks and the economy was always overdone, if not completely spurious. Mortgage delinquency rates have fallen to cycle lows. The mortgage debt servicing ratio is well contained and unlikely to move up that much with 25 or 50 basis points of Bank of Canada hikes, so long as the tighter labour market and the gobs of full-time jobs that have been created in recent months translate into compensating household income growth.

Canadian homeowners have an average of 75 per cent equity in their houses and that number has climbed back to an all-time high.

So even the horror stories around the usage of home equity lines of credit a few weeks back was nothing more than a ruse. This equity cushion means it would likely take a monumental bear market in home prices, and not just Toronto and Vancouver but also in the other 70 per cent of the country, to generate a U.S.style default experience circa 2007-09.

And for all the chatter of dilapidated household balance sheets, while this may well be true on a debt-to-income basis, the opposite is true when outstanding household balance sheets are normalized by net worth. This ratio has receded to below 20 per cent, the lowest it has been in over a decade.

Contrary to popular belief, we haven’t all been borrowing massively on the credit card to go on a vacation as much as to take on mortgages to invest in real estate — keeping in mind that virtually every part of the country, and that includes residential real estate in the GTA, is actually inexpensive in Canadian dollar terms when measured against other global centres like London, New York, Paris, Tokyo, Frankfurt, Hong Kong as well as Sydney.

So where is the Canadian dollar going next?

Well, only half of the “bad news” that the currency markets had priced in during the spring has vacated the premises. Since the end of May, the net speculative short position of the Canadian dollar on the Chicago Mercantile Exchange has gone from 99,736 futures and options contracts to 49,497 currently, and during that time, the beloved loonie has rallied five “big figures” to $1.30 per U.S. dollar. So dial me up once the remaining net shorts run for cover, which alone could well be powerful enough to drive the Canadian dollar up another five big figures to $1.25, and we can talk then about where to next.

As tempting as it may be to turn neutral or even bearish at that point, if Stephen Poloz takes back both of the 2015 “emergency” rate cuts, not just the one that the futures market is discounting, and if oil can make it back to US$50 per barrel for WTI crude, then we could well be talking about a return to $1.20.

All of a sudden, those Yankee tickets won’t look so bloody expensive!

Contrary to popular belief, we haven’t all been borrowing massively on the credit card to go on a vacation.