Question of the Week by Richardson GMP

A lot has happened in the capital markets over the past month or two. The Americans, Japanese, Chinese and Europeans have been making all kinds of noise (both good and bad) that may have distracted your attention away from the fact that the Canadian dollar has fallen against the U.S. dollar. Admittedly, the loonie has bounced back by just under two cents this week, but it still trades at a level we would consider low relative to where it’s been for the past three years.

Is the most recent decline a sign that the Canadian dollar is at the beginning of a longer term decline against its U.S. counterpart? Yes, this scenario is quite possible. To explain our rationale, let’s look at what is influencing currency markets at present. First, as explained in our Quarterly MarketPoint publication, many countries around the world are trying to weaken their currency to make exports cheaper and boost economic growth. Such a move saw the U.S. trade weighted dollar strengthen to levels not seen since 2010 and created a scenario where the U.S. dollar was the big winner in the currency market while every other currency (including the loonie) came under selling pressure. Considering what’s currently going on in Europe and China from an economic growth perspective, we expect fund flows will continue moving into U.S. dollars in the coming quarters. Second, whether justified or not, Ben Bernanke’s back and forth discussion about "tapering” bond purchases has left investors with the impression that U.S. monetary policy may be set to turn. Such a scenario, in conjunction with higher bond yields, has strengthened the U.S. dollar even further.

So where does this leave the Canadian dollar? First we’d note it’s fair to say the loonie has been a victim of U.S. dollar strength more than Canadian weakness. However, a decline in various commodity prices thanks to a slowdown in China and the recent plunge in the bullion market have only exacerbated the decline of the loonie. It’s only saving grace from a commodity perspective is that oil prices have held up well due to geopolitical events in the Middle East, but we expect oil prices to come under pressure from a fundamental supply/demand perspective.

What is clear is that the world no longer views the U.S. dollar as a relatively weak currency as it’s now the currency of choice for traders that need safety and stability. We don’t expect this view to change in the near term, so we would not be surprised to see the Canadian dollar remain in the mid 90 cent range, if not weaken further going forward. We certainly feel it will be very difficult for the loonie to retest parity without a resurgence in commodity markets or an unexpected decline in U.S. economic growth.

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