'I think where we're going is sixty-nine cents': McCormick on CAD relative to USD

Key Concepts

• Hawkish Monetary Policy: A central bank stance favoring higher interest rates to combat inflation.
• Forward Guidance: Communication from central banks to the public regarding the future path of monetary policy.
• Term Premium: The extra compensation investors demand for holding long-term bonds instead of rolling over short-term investments.
• Data Dependency: A policy approach where central bank decisions are based on incoming economic data rather than pre-committed paths.
• Macro Regime Change: A fundamental shift in the economic environment (e.g., moving from low to high interest rates and inflation).
• Neutral Rate: The theoretical interest rate that is neither expansionary nor contractionary.

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1. The Outlook for the Canadian Dollar (Loonie)

Mark McCormick, Chief FX Strategist at Capital Markets, identifies the Canadian dollar’s weakness as a byproduct of a "broad US dollar market."

• Current Status: The CAD is trading at approximately 70.5 cents US.
• Forecast: McCormick predicts the currency could touch 69 cents US.
• Primary Drivers: The divergence between the US and Canadian economies and their respective central bank policies. While the CAD is influenced by risk sentiment, the strength of the US economy remains the dominant factor.

2. The US Dollar Pivot and Economic Resilience

McCormick argues that market consensus at the start of the year was incorrect regarding the US dollar.

• Failed Predictions: Analysts expected the Fed to cut rates, the US economy to weaken due to trade uncertainty, and investors to diversify away from US assets. None of these materialized.
• US Strength: The US economy has shown significant resilience, accelerating in Q2, while US equities continue to outperform global markets.
• European Vulnerability: Europe’s growth story was disrupted by an energy shock and low natural gas inventories, which crippled their manufacturing sector and left them vulnerable to a growth shock.
• The "Dollar Positive" Regime: Because US equities, interest rates, and trade terms all favor the dollar, it remains the dominant reserve currency.

3. The "Kevin Warsh Era" and the End of Forward Guidance

A significant shift is occurring in how central banks communicate with markets.

• Reduction in Guidance: Central banks, spearheaded by figures like Kevin Warsh, are moving away from providing explicit forward guidance.
• Rationale: Forward guidance was designed for an era of quantitative easing and low rates. In a world of higher inflation and external shocks (geopolitics, fiscal policy, energy shocks), central banks have struggled to accurately predict GDP and inflation.
• Return to Fundamentals: The market is returning to a pre-financial crisis model where investors must analyze raw economic data rather than relying on central bank "dot plots" or promises.

4. Market Volatility and Investor Strategy

McCormick addresses the concern that removing forward guidance will increase market volatility.

• Volatility vs. Uncertainty: While the current era is defined by economic and geopolitical uncertainty, volatility is a measurable market dynamic that can be hedged.
• Actionable Insight: Investors should stop trying to "read" central bank rhetoric and instead focus on fundamental macroeconomic analysis. Understanding the underlying drivers of the economy is now more critical than interpreting policy statements.

5. Interest Rate Projections

McCormick challenges the current market pricing, which anticipates 50 basis points of cuts in the US over the next year.

• The "Hike Before Cut" Thesis: McCormick believes the market is wrong to price in cuts. He suggests the Fed is more likely to implement a rate hike—potentially as early as July, with a baseline expectation of September.
• Higher for Longer: The expectation is that the Fed will move toward higher neutral rates and maintain them for an extended period, rather than reversing course.

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Synthesis

The global macro environment has undergone a regime change that favors a stronger US dollar. The primary takeaway is that the era of relying on central bank forward guidance is ending. Investors must pivot toward rigorous, data-driven macroeconomic analysis to navigate a landscape characterized by higher interest rates, persistent uncertainty, and a Federal Reserve that is increasingly hawkish and data-dependent.