This year’s vote could have negative consequences for the Loonie.

Canadians head to the polls on Monday, October 19th in what is shaping up to be a “changing of the guard” event. The incumbents Progressive Conservative party (PC) are almost certain of losing their majority and will be hard pressed to win more seats than the resurgent Liberal party (Grits), led by Justin Trudeau. The New Democratic Party (NDP) started strongly but appears doomed to lose their status as “official opposition” and return to their habitual “also ran” status.

The Canadian dollar has been oblivious to Federal elections for all of this century and rightly so. The campaigns were frequent (this is the 6th election since 2000) and the party platforms fairly similar.

However, the 2015 vote is different. The Liberal Party is rising from the grave.

Chart: Latest Polls with seat projections

Source : ElectionAlmanac.com

In the 2011 election, the Grits lost 42.86% of the seats they held going in, dropping to 34 seats from 77 and it cost then leader, Michael Ignatieff, his job. The latest 2015 election polls project the Liberals winning 133-143 seats, a tad shy of the 170 needed for a majority.

And all the gains are coming on promises to expand budget deficits and raise taxes.

Traditionally, these types of promises would relegate the candidates to the back of the line when the votes are counted. Not so in 2015.

Canadian dollar rises on external influences

The Canadian dollar is soaring. USDCAD has dropped from 1.3450 two weeks ago to its current level of 1.2840 a 4.5% gain or 0610 points. And none of that move has anything to do with Canadian fundamentals or the election. Arguably. The Canadian dollar is benefitting from the capitulation of long dollar positions precipitated by inertia from the US Federal Reserve and the perception the anticipated rate hikes in 2015 have been pushed out to sometime in 2016.

It is a fair assumption that International investors, if they know about the Canadian election, just don’t care. But maybe they should and will.

Loonie (perhaps looney) Election Scenario’s

Liberal Majority: A Liberal majority, may be unlikely, but the possibility is there. If so, USDCAD should rally on expectations of an expanding budget deficit, higher taxes choking off investment especially if they adopt the greener infrastructure initiative. Their plan for the environment includes issuing Green Bonds to fund environmentally friendly energy projects. That isn’t a new plan. It is a similar strategy that the Ontario Liberal party put in place over a decade ago. That has resulted in electricity prices in the province doubling in seven years and a loss of over 300,000 high paying manufacturing jobs since 2000.

On the other hand, depending on the infrastructure projects that a Liberal government would fund, short term job creation could cut unemployment and give the Loonie some support.

More than likely, a Liberal win is the Loonies loss.

Liberal Minority (with NDP support): This appears to be the most likely scenario. As of October 13th, 3 polls have the Liberals winning 133, 140 and 143 seats, still shy of the 170 seats need for a majority. The outcome for the Loonie shouldn’t be a whole lot different from that of a Liberal majority government as for the most part, Liberal and NDP policies are inter-changeable.

Loonie loses under this scenario as well.

Conservative Minority : It is still a possibility as polls have been known to be wrong. However, the impact on the Canadian dollar should be negligible. The government is well-known, so no surprises.

Conservative Majority: This would be a highly unlikely outcome, based on the polls but if it happened, it would have no impact on USDCAD.

Election aftermath

The reality is that the Canadian election outcome will have a bigger impact on the lives of Canadians than it will on the currency at least in the near term. For starters, a new leader will not be in any position to implement any policies for a few months.

US dollar sentiment is the biggest driver of the Canadian dollar (and rest of the G-7 currencies) at the moment and that sentiment is negative. It has been for a couple of weeks and like a snowball rolling down a hill, it has gotten bigger and bigger. The question is whether it will keep on rolling or is it close to the bottom.

US dollar sentiment in the driver’s seat

The long US dollar trade was one of the most popular trades this year. That started to change with a series of weaker-than-expected US economic reports and signs that the Federal Open Market Committee (FOMC) members were squabbling. That led to some US dollar selling. The dollar selling intensified with the Chinese equity market meltdown in late August leading to increasing nervousness over the scope of the Chinese economic slowdown. The selling has intensified over the past week as various FOMC members chimed in with a variety of conflicting and contradictory opinions.

In addition, US Treasury yields have collapsed; 10 year Government bonds are currently at 2.02%, down 48 bps since June, a clear indication that markets do not believe the US rate hike story any more. At the same time, 2 year Canadian bond yields have risen, coinciding with the latest Canadian dollar rally.

As long as US dollar sentiment remains negative, USDCAD gains will be limited, regardless of any election outcome.

Chart: Canada 2 year bond with USDCAD overlay

Source :Investing.com

Blame it on the Fed

This election is a big deal for Canadians. Why? It’s because it will give voters time to prepare for the next one if it is a minority government. And that will probably be within 2 years. Unfortunately, the dominance of the US in global trade makes the Loonie hostage to developments south of the border. If you think getting Tory’s, Grits and the NDP to agree on anything, recent developments with Federal Open Market committee members suggest that the Fed is having a similar problem. Until they get their act together, domestic developments will have little sway on USDCAD direction.

By David Marks, FX Analyst, Agility Forex