The loonie is on fire, but for how long?
The loonie is on a tear that has seen it gain six cents since bottoming out at just above US68 cents in March, but some analysts are warning the currency’s rise is likely unsustainable and are expecting another sell-off.
A combination of the global economic shutdown and declining crude prices in the wake of an oil price war launched by Saudi Arabia sent the Canadian dollar plunging from about US75 cents in early March to as low as US68.18 cents, its lowest level since 2016. It traded for US74.05 cents Wednesday compared with US73.99 cents on Tuesday.
But much like the equity markets, that trend eventually reversed itself, particularly over the past month when the loonie has gained four cents.
Sun Life Global Investments chief investment officer Sadiq Adatia said the recent reversal is more strongly associated with the U.S. dollar’s weakening position. Investors flocked to the greenback in search of a safe haven during March, he said, and as equity markets continue to roar, they’re slowly beginning to take on more risk again. That includes investing in other countries, Adatia said.
“We’ve seen money start to flow out of the U.S. dollar and back into other currencies as risk-on trade starts to come back a bit and you see markets rebound,” Adatia said.
“On top of that, our currency is still a commodity currency — it got the benefit that we’re starting to see oil prices rebound.”
The loonie’s move is coming amid a hint of a rotation in the U.S. equity markets, Adatia said. The past weeks have seen stocks in the more beaten down sectors such as airlines, retail, restaurants and energy begin to rally while technology is on a less torrid pace. Adatia thinks this is particularly true when it comes to the new money entering the market.
Canada is a sound target for that strategy. Outside of Shopify Inc., there are few technology companies in the country that would draw the eyes of an international investor. What the TSX is ripe with are firms in the energy and financials sectors, both of which have benefitted in the past weeks from that early rotation Adatia described.
The loonie’s rally to the greenback has actually led performance in the G10, according to TD Securities senior FX strategist Mazen Issa. Like Adatia, Issa attributes the recent move to the capitulation of the U.S. dollar. Rising oil prices have helped, although the link between the currency and crude prices may not be as sensitive as people think. And in the last two cents of this rally, from 72 to 74, Issa spotted a short squeeze.
“Basically, it’s been the perfect storm,” said Issa. “In the grand scheme of things, CAD is a price taker and is getting pulled along for the ride in risk assets.”
That’s likely why the rally isn’t meant to last. The loonie’s current levels should encourage caution, he said, because a lot of the good news in relation to the recovery from COVID-19 is already built in. The momentum of the rally could take it to 75 cents before the expected drawdown hits, and the Canadian currency is dragged back to 72 cents.