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Expectations for more tightening from the Bank of Canada have shot up since this morning’s hotter-than-anticipated inflation report, with at least one hike priced in by the March meeting in early 2024. The loonie has jumped even more aggressively, reflecting oversold conditions going into the release (which were arguably reinforced by the psychological bias known as “round number anchoring” around the 1.35 mark) and a supportive oil-price backdrop.

But don’t expect the effect to last. 

For much of the last few decades, the Canadian dollar seemed to act like a “petro-loonie”, with oil prices playing a big role in driving a lot of price behaviour, that’s no longer the case (if it ever really was). The exchange rate is far more tightly correlated with shifts in US market sentiment – expressed here using the S&P 500 – than with oil prices. And rate differentials are driving the bus to an even smaller degree.

With that in mind, the biggest threat facing the Canadian dollar in the months ahead might not have anything to do with oil prices, domestic economic conditions, or the Bank of Canada: if the US artificial intelligence bubble pops, it’ll take the loonie down with it. So it might be a good time to remember Carl Icahn’s comment: “Some people get rich studying artificial intelligence. Me, I make money studying natural stupidity”.

Will the positive vibes last?
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Higher for (even) longer