In the November 2015 edition of The Professional Advisory, I wrote about our view on the loonie. “It sometimes feels to me that every Canadian I know is a currency speculator. In some ways, we all are. We need US dollars to travel and if you’re like me and the families our firm works with, buying US dollars is an annual transaction.”
While it is impossible to predict the short-term fluctuations of the loonie, our firm is forced to make some short-term calls to assist our clients in financing their lifestyle in USD.
So where are we now?
Over the past couple of years, we have fluctuated between $0.73 and $0.80 Canadian dollars to buy one US dollar (see the attached chart). At the time of this writing we are at around $0.75.
The Bank of Canada (BoC) left its benchmark interest rate unchanged this week at 1.75%, citing worse-than-expected economic growth. The slowdown that began in Q4 of last year has intensified, with the decline in Canada’s oil industry, China trade tensions and housing costs. The Bank also said the timing of future rate hikes is now more uncertain. Indeed, some consider the odds favour the next move in interest rates will be to the downside.
The three most important drivers of the Canadian dollar are Central Bank policy, relative economic performance with the United States, and commodities, particularly oil. All of them currently appear to be set up to put additional downward pressure on the loonie.
Canadian Central Bank policy has turned decidedly dovish, like the US Fed, due to concerns about a potential global economic slowdown and a weaker Canadian domestic economy. Normally, when the Bank raises interest rates, the effect is to lift the domestic currency. Now that further rate increases appear to be on hold, this potential support for the Canadian dollar is absent.
Our next-door neighbour and largest trading partner, the US, is ten times our size. Canadian economic performance relative to that of the US has been lagging for some time. In addition, the US dollar remains the currency of choice for global investors for yield and safety. Economic outperformance and high demand for the currency provide underlying support for the US dollar. The dual effect of a stronger US economy and a lagging Canadian economy negatively pressures the CAD/US exchange rate.
Oil has also proven to be no help to the loonie. Typically, stronger oil prices cause our dollar to rise. However, even as oil increased from US$48 to US$76 last year, the Canadian dollar fell from US$0.83 to US$0.77. It has weakened further since then.
Macro-economic and political factors unique to Canada such as trade wars, tariffs, pipeline and regulatory issues have also played an increased role in the weakness of the Canadian dollar. Foreign capital and investment have been exiting Canada as business confidence has deteriorated.
The accompanying chart illustrates the difficulties the Canadian dollar is experiencing. Even while rates increased and oil prices rose between September 2017 and October 2018, the loonie remained in a well-defined downtrend. With the recent market recovery, it rebounded once again to the upper trendline before falling to the current level of US$0.745.
Barring any near-term improvement with respect to oil and the Canadian political environment, given the BoC’s move to keep rates steady amid a tepid economic outlook, we think the Canadian dollar will continue to drift lower in the short term.
