By Fergal Smith
TORONTO (Reuters) - The Canadian dollar is losing its usual tight link to the performance of U.S. stocks as investors pay more attention to domestic economic headwinds than signs of improved prospects for the U.S. economy.
The signal that Wall Street sends about the U.S. economic outlook tends to be an important driver of the loonie because Canada sends about 75 percent of its exports to the United States, including many commodities such as crude oil.
But the correlation between the S&P 500 and the Canadian dollar has collapsed since March, with the loonie losing ground even as U.S. stocks notched a record high.
(GRAPHIC-Canadian dollar and U.S. stocks delink link: https://tmsnrt.rs/2WmFgoi)
The market's message is "we're confident in U.S. growth, we're confident in U.S. corporate profitability and normally that would spill over to Canada, but right now we're worried about the Canadian consumer, Canadian housing, Canadian natural resource investment," said Adam Button, chief currency analyst at ForexLive.
The Bank of Canada last week slashed its gross domestic product growth forecast for the year to 1.2 percent from 1.7 percent in January, blaming a slowdown in the country's oil sector, a weaker-than-expected housing sector and the negative impact of global trade policies.
Trade uncertainties, including negotiation of a new trade deal between Canada, the United States and Mexico, were a drag on the loonie when its correlation with U.S. stocks last broke down in July 2018.
The three countries struck the United States-Mexico-Canada agreement (USMCA) last September, but the chances of the countries ratifying the pact this year are receding.
Meanwhile, the rally in oil prices since December of as much as 57 percent has not led to increased investment in Canada's energy patch, while a lack of pipeline capacity has capped the amount of oil Canada can get to the global market.
"People are realizing that we're not a petrocurrency and that there is a much larger, much more important household consumption sector," said Karl Schamotta, director of global markets strategy at Cambridge Global Payments.
In the fourth quarter, household spending was about 57 percent of Canada's gross domestic product, according to data from Statistics Canada, while household debt as a share of income widened to a record 174 percent.
Canadians have taken on record amounts of debt in recent years, fueling a rapid rise in real estate prices. But the housing market has softened since the start of 2018, weighed down by tighter mortgage rules and interest rate hikes from the Bank of Canada.
"You could see the interest burden on Canadian consumers rise to a pace that it becomes difficult to manage," said Scott Smith, managing partner at Viewpoint Investment Partners.
In a potential sign that investors have become worried about a recession in Canada, the country's yield curve inverted in March for the first time in more than a decade.
"The market is getting much more picky about some of the domestic headwinds facing individual countries and less likely to believe that rising global growth will float all boats," ForexLive's Button said.
(Reporting by Fergal Smith; editing by Steve Scherer and Chris Reese)