USD/CAD: NFP and the dangers of capital flows - TDS

Mark McCormick, North American Head of FX Strategy at TDS, suggests that today’s NFP report will set the tone for markets for the next few weeks.

Key Quotes

“Indeed, the market’s confusion rests on whether last months dreadful report was a fluke or the start of a trend reversal in US labour market dynamics: each scenario has adverse impacts on risk assets and USD/CAD.

A decent report around reinforces that growth has not fallen off a cliff. This would probably underpin risk sentiment since it is unlikely to move the needle on the Fed in Q3 but shows that growth is still humming along above 2.0%. This probably keeps USD/CAD below 1.30 for the session and is negative for the USD overall. A healthy number (closer to 200k) probably sees the reverse with CAD and the rest of the G10 probably lower against the USD as Fed pricing shifts again.

Alternatively, a weak number (120k and below) supports the argument that the labor market is quickly losing steam. While some observers might think this is good for risk since it keeps the Fed on hold for longer, it is likely to weigh on sentiment since it would lead to questions about the state of the economy. This scenario would likely result in CAD and other risk assets underperforming. We could see USD/CAD test the upper end of the range near 1.31 with 1.33 beckoning.

This report matters quite a lot for USD/CAD since risk sensitive flows have probably supported CAD since the start of the year. US stocks have lagged Canadian stocks since the onset of the year. This relative performance is also consistent with a pickup in capital flows to Canada. Canada has seen about $25bln in capital inflows in Q1, reflecting in part the recovery in oil prices and a weaker currency. However, these flows could reverse if sentiment continues to sour, weighing on commodities and equities.

Finally, today’s numbers in the US and Canada should buttress the divergence theme between the US and Canada. The final chart shows the spread between annual payroll growth in the US and Canada. What is clear is that employment growth diverged early in this cycle, and the spread between the respective labour markets is the widest since the 1990s. This argues for further policy divergence between the Fed and BoC, especially since the OIS curve is only pricing in a 50% chance of a 25bp rate over the next two years and next week’s BoC meeting could see a dovish turn.”