WHILE GREENBACK SOARS, LOONIE IS LOOKING VULNERABLE.

While it may not be important to those Canadians who don’t travel abroad, currency fluctuations do matter when it comes to balance of trade, interest rates and overall monetary policy — all of which can have a material economic impact.

These are very interesting times as most central banks outside of the U.S. are still trying to stimulate their economies while the U.S. Federal Reserve has turned hawkish. In particular, with the election of Donald Trump and his anticipated fiscal policies, markets are discounting three rate hikes in 2017 sending the U.S. dollar to near 14-year highs and breaking it out of its recent trading range.

As to the potential upside to the dollar from here, one may look to what happened in 2015 when pundits were also expecting three to four rate hikes sending the dollar (DXY) rocketing nearly 27 per cent higher against a basket of currencies including the euro, yen, pound sterling, Canadian dollar, Swedish krona and Swiss franc.

Investors responded to that dollar strength by sending commodities crashing lower along with emerging markets. Specifically, the Bloomberg Commodity Index and MSCI Emerging Market Index fell approximately 46 per cent and 36 per cent from their respective July, 2015, peaks to their January, 2016, bottoms. Here in Canada, our resource heavy S&P/TSX also fell approximately 22 per cent over the same period.

This time around, while the U.S. dollar is up over 10 per cent from its May, 2016, lows and five per cent since the election, it has not been the wrecking ball as it was in 2015, but rather the opposite: The Commodity Index, the Emerging Market Index and the S&P/TSX are all up over the same period and more so since the beginning of last year.

For example, the Commodity Index, the Emerging Market Index, and S&P/ TSX are up 18 per cent, 26 per cent, and 28 per cent from their respective January, 2016, lows compared to a three-per-cent increase in the dollar.

We think this means investors are not factoring in the potential for another rocketing U.S. dollar scenario, which is strange given what is currently transpiring in the bond markets, which are saying the opposite.

In addition, capital is once again leaving emerging markets, sending their currencies to new decade lows. For example, China has been forced to sell a record amount its foreign exchange reserves held in U.S. Treasuries in order to shore up its yuan. The alternative is to raise interest rates, not unlike what has recently happened in Mexico.

Here in Canada, our fiveyear Government of Canada bond yield has doubled from its summer lows causing the banks to raise mortgage rates, which is not good news for homeowners. However, our loonie has held up fairly well this year against the dollar probably due to OPEC’s recent support for the price of oil.

That said, there has been an interesting development that is worth keeping a very close eye on. Not surprisingly, the loonie has exhibited a strong correlation to oil. However, while it did move with the OPEC announcement of production curtailments it has recently given back all of those gains, while oil has remained higher.

We wonder if this means oil has stopped being a floor to the downside and if so, this is not a favourable development for the loonie.

This isn’t necessarily bad news for the Canadian economy as a modestly weaker currency will help our balance of trade and higher oil prices will stimulate growth once again in Western provinces. For example, activity levels in the oilpatch are picking up with the Canadian rig count surging 31 per cent last week and up 23 per cent from last year. Alberta also saw its economy add 18,500 full-time jobs — more than offsetting the 11,600 loss in part-time positions in December.

We do worry though that this early momentum could be undone should the price of oil fall back down with the loonie and bond yields and mortgage rates continue to rise, creating the perfect storm for the Canadian economy. In our opinion, this is a potential risk especially if the U.S. dollar continues to react like it did in 2015.