Australia and Canada are literally on the other side of the world from each other but there is a high degree of commonality between the two economies than meets the eye.
Both countries are heavily reliant on commodity exports where the underlying value of the export has decreased dramatically in the last 2 years. Both countries have an inflated residential real estate market where the marginal buy is fueled by Chinese capital outflows.
Crude oil is a key commodity export for Canada, similar to Iron Ore and Coal for Australia. The decline in the price of crude oil since 2014 has been the primary driver for the depreciation of the Canadian dollar against major FX pairs.
Due to Canada’s close geographic proximity to the United States and close economic relationship. Canadian monetary policy have mirrored the Fed interest rate to a large extent in the last decade. The target overnight rate is exceedingly low by historical standards with a brief return to normality when Bank of Canada raised rates from 0.25 to 1% in 2010.
Bank of Canada has responded to the recent manufacturing slowdown and weak export income through cutting interest rates back to 0.5%.
We have written extensively on the fall of the Australian dollar. In our Australian dollar to US dollar forecast, we see the impact from the fall in commodity prices as largely priced in. Although there is still a degree of volatility in the day to day movements of the exchange rate, the medium trend is flat to up from current levels.
Whilst the oil price has recovered since bottoming in February 2016, only time will tell if the price remain where it is today.
AUD vs CAD – Medium term range bound
Currencies values are relative. Australian to Canadian dollar has traded between the range of 91 cents to 1.08 and it is at the lower end of the range today.
If Australian to Canadian dollar exchange rate breaks this range then there would be a fundamental shift in the price where it could land mid 0.85. In our view, barring any unforeseen disasters coming out of China the lower bound of the range should hold.
As the AUD to CAD rate approaches the lower bound we would set a stop below the lower range limit. On a relative basis, we would still back AUD against CAD in the medium term while neutral on the long term time frame.
The recovery in oil prices will not be a straight line, a lower for longer oil price forward curve will put Canadian oil assets at a structural disadvantage. The cost curve of Canadian oil sands is higher because of the lead time required and nature of extraction method.
US shale are more nimble, can restart faster and more profitable at same price per barrel than Canadian oil. This would limit the extend in the bounce and support further downside in the CAD to AUD exchange rate.
Key risk for both economies is a hard landing and faster than expected fall in house prices. See our analysis of potential Sydney housing bubble. We have somewhat tempered our view since RBA reduced interest rates in response to lower realized inflation. Bank of Canada does not have any room left in cutting rates further.
Stories like this shows the true excess in the Canadian real estate market. What goes up must come down. The market has not price any material slowdown but business as usual for the real estate market. We see this as a key risk going forward.