Look for a 75-cent loonie when dollar comes off its ‘sugar high’
The loonie may be in for some turbulence after enjoying several sweet months of success against the U.S. greenback, according to some forecasts.
The Canadian dollar fell below the 82-cent US mark on Thursday, tumbling as far as 81.75 cents US as of midday. The dip followed an approximately 13.5 per cent increase in the loonie’s value over the summer, which pushed it past 82 cents US last week to a two-year high.
“Probably the biggest move we’ve seen for anything Canadian has been the loonie over the past several months, which has risen dramatically,” said Craig Fehr, Canadian investment strategist at Edward Jones, in an interview with the Financial Post. “I think it’s on a bit of a sugar high. And I think it’s probably due to come back a little bit in the short term.”
Fehr said the sugar high stemmed from expectations of a sluggish Canadian economy and a stationary Bank of Canada, as well as stronger economic activity in the U.S. and a Federal Reserve that looked to be on a tightening cycle.
Instead, the Canadian economy has surged and the Bank of Canada has pivoted towards a tightening cycle of its own. The central bank hiked its benchmark rate by a quarter point in both July and September, the first increases in about seven years.
“That wasn’t in the market at a 70-cent loonie,” noted Fehr.
A note from Capital Economics said the Bank of Canada’s “unexpectedly aggressive monetary tightening this year, which stands in stark contrast to the Fed’s overcautious approach, largely explains the surge in the Canadian dollar this year.”
But what’s past may not be a prologue for the Canadian dollar.
“After ending this year at US $0.81, we expect the Canadian dollar to fall back to US $0.75 by end-2018,” wrote Capital economist David Madani. “Overall, the Canadian dollar has likely peaked this year and will fall back next year as a domestic slowdown forces the Bank of Canada to flip from hawkish to dovish, while rising inflation will prompt the US Fed to flip from dovish to hawkish.”
Fehr said he expects softer economic growth in the second half of 2017, which will coincide with the Fed’s tough talking ways.
“Which means that I think we probably revert back a little bit,” said Fehr of the loonie. “And I think something in the high-70s, maybe even mid-70s is probably more appropriate as that environment plays out.”
RBC Global Asset Management said the Canadian economy “has turned out to be the ‘little engine that could’” this year, including the 4.5 per cent rate of annualized economic growth it posted for the second quarter. The good economic news “fell onto the parched ground of expectations,” but Canada still faces headwinds on the horizon, RBC said, such as U.S. protectionism and shale oil production that can tamp down prices.
“We believe that buying the Canadian dollar at current levels because BOC is hiking is like driving a car looking only in the rearview mirror,” wrote Dagmara Fijalkowski, head of global fixed income and currencies at RBC Global Asset Management. “What we should ask is: What’s ahead given that economic data surprises have been ratcheted up, the currency has strengthened and the Trump administration has disappointed?”
Fijalkowski said that “the current backdrop leads us to believe the Canadian dollar will fall back to levels that compensate for Canada’s lack of competitiveness, and that the currency will have to remain weak for some time.”
Fehr said another Bank of Canada rate hike can’t be taken off the table. However, he added, avoiding another hike may be the safer move.
“After two rate hikes, I think it’d be more prudent for the Bank of Canada to take a pause and see what the effects might be, particularly to consumers and to the housing market, and to the loonie, quite frankly, because with a higher loonie it’s suppressive of export growth,” Fehr said.