What's UP with the Canadian Dollar?

Rather what’s down with the Canadian dollar (“Loonie”)? Since breaking above parity in the winter of 2010 to the summer of 2011, it has been on a steady decline against the greenback. More recently, in the past quarter, the chatter in the currency pits around the world has been the low demand for the Loonie, despite solid economic data from our largest trading partner, the good old US of A. One of the questions that we keep hearing is: will the Loonie continue to sink lower relative to the US greenback?


The answer is likely a bit of fortune telling, because we know the facts can change quickly in the macro environment. However, let’s consider the current facts and state of the union, for a moment.


The Loonie has been under selling pressure as energy and commodities, in general, are in weak demand, hence lower prices. Oil represents the largest component of commodity values in our Gross Domestic Product (GDP) economic indicator. GDP is simply the value of all goods and services produced in our country. Commodity weakness has also translated into weakness in the private sector in Canada. There are many service industries intrinsically tied to commodities.


The chart below shows the Currency Shares Canadian Dollar Trust – FXC. This is basically the Canadian dollar versus the US dollar.


Source: VIP Wealth Solutions and Bloomberg


If we were to overlay oil against this chart we would see a pretty common relationship.


Source: VIP Wealth Solutions and Bloomberg


It might be safe to say that as goes the barrel of oil, so too goes the Canadian dollar. At least that appears to be what is happening right now. However, oil is not the only story. What about rates and the overall Canadian economy?


If interest rates in Canada were to move higher it would be a natural response to think that the Canadian dollar may move higher on this raise. On December 3rd, 2014, the Bank of Canada announced their decision that interest rates would not change from the current 1% level. A longer term perspective, with the next chart, tells a bit of the story. Sitting at 1% for the past 4 years presents only a few options: rates could go higher or rates could go sideways. In theory, rates could also go down a bit but the economy would have to get really bad again like it did in 2008 through 2010. A best guess at this point would be sideways or higher.


Source: VIP Wealth Solutions and Bloomberg


So now we look at what makes rates go higher and the largest catalyst, one could argue, would be economic growth. Recent comments out of the Bank of Canada suggest lower growth. In recent commentaries it has been suggested that the Bank of Canada is not expected to raise its benchmark rate until the U.S. Federal Reserve lifts interest rates, likely sometime in 2015; it appears that we are once again back at a point of the dog wagging the tail again.


Canadian growth is difficult to predict, however the impact of lower oil prices, has been suggested, will add $1.3 trillion to the consumers pocket.  This could be equivalent to 1.7% of global GDP. Some of this will trickle into Canadians pockets. There is more to this comment than meets the eyes, as oil producing companies are cutting back given the decline in oil prices. So, the net effect is something smaller. Regardless, we know that lower oil prices puts money in our pockets.


The intent of this was not to predict the direction of the Canadian dollar but to articulate some of the levers that affect the state of dollar direction. Our current posture remains that the Canadian dollar will remain weak relative to the US dollar. However, we also know that this will change going forward and with that change, so too will our thinking.