Sluggish Economy Could Hammer CAD-USD Exchange Rate
For those of you who were expecting the Canadian dollar exchange rate to rally against the greenback, think again.
As the latest Canadian dollar forecast from the Bank of Nova Scotia reports, the Loonie could soon be dropping to as little as US$0.72. (Source: “Scotiabank forecasts Canadian dollar below 80 cents until end of 2017,” CBC, November 4, 2015.) But the gloomy news doesn’t stop there, because the subsequent recovery is not forecasted to be substantial, and might even top out as low as US$0.80 until well into 2017. (Source: “Canadian dollar forecast to sink to 72¢, remain stunted through 2017,” Globe and Mail, November 4, 2015.)
Should Investors Bail on the Canadian Dollar?
Just as in the U.S., the big question on everyone’s mind is of course the issue of interest rate hikes.
Interest rate differentials will work against the Canadian dollar, if and when the U.S. Federal Reserve decides to raise rates, perhaps as early as the first quarter of 2016. This is due to the fact that the Fed is inching closer to raising interest rates while the Bank of Canada is not expected to revisit interest rates in the near term. (Source: “Canada’s weak economic growth could get boost from Trudeau’s stimulus, economists say,” Financial Post, October 30, 2015.)
This policy choice is largely the result of low energy prices, particularly crude oil, for which there is no expected price rally until the end of 2016 at the earliest. But there is also the notable problem of stagnating domestic economic growth, with the Canadian gross domestic product exerting continued negative pressure on the Canadian dollar.
Scotiabank places the Loonie at around US$0.73 at the end of this year, while the above-mentioned decline to US$0.72 is forecasted to occur by the middle of 2016. (Source: “Canadian dollar forecast to sink to 72¢, remain stunted through 2017,” Globe and Mail, November 4, 2015.) Little growth is expected into 2017, with Q4 2017 estimates limping along at US$0.79. But Scotia, Canada’s largest bank, is not alone in its bearish sentiments. A recent Canadian dollar forecast by a Merrill Lynch foreign exchange strategist estimates that the Loonie will drop down to around US$0.74 within a few months and remain there for the rest of 2016. (Source: “Money is flooding out of Canada at the fastest pace in the developed world,” Financial Post, November 2, 2015.)
But these forecasts might still be too optimistic, because if current trends continue, it is not altogether inconceivable that the Canadian dollar will absolutely plummet down to half the greenback’s value. I’m talking about the Canadian dollar forecast being humbled down to US$0.50.
Chart courtesy of www.StockCharts.com
A slumping Loonie will be disastrous for Canadian visitors heading south of the border for lucrative shopping deals, as well tourists on vacation. But that’s only the small-scale effect on regular people, because there are also a host of larger issues at play. U.S. imports into Canada have surged in price, and consumers have been hit hard by rising prices on many everyday goods coming from the country’s largest trading partner.
What the Bank of Canada is betting on are strengthened exports, which will be contrastingly given a boost by the crash in the Canadian dollar’s value. Therein lies the double-edged sword in currency fluctuations: if the value of your own currency rises, it will make foreign imports more expensive because you’re spending the same amount with less money. On the flip side, your own exports to other countries are cheaper for foreigners to purchase, and this should boost your exports in theory.
The Bank of Canada is endeavoring to restructure the Canadian economy from depending on domestic-driven growth drivers to one in which international trade and investment take the driver’s seat. (Source: “Where is Canada’s economy headed? Notes for the new finance minister,” Globe and Mail, November 4, 2015.) But this policy direction has only been somewhat successful, according to the Scotiabank report.
While trade levels have shown some improvement in the last six months, foreign direct investment (FDI) has essentially flatlined as a drive in the Canadian economy. This should be contextualized within the ongoing crisis in global energy prices, where crude oil has lost approximately half its value since the summer of 2014.
The Bottom Line on the Canadian Dollar Forecast
While the energy sector is not the primary driver of the Canadian economy, it was the recipient of a disproportionate amount of foreign investment. With all of the world’s largest energy companies making huge budget cuts and throttling back investment in an effort to adapt to the low oil price environment, the economic effects of this reality have hit the Canadian oil sands particularly hard. (Source: “Oil Megaprojects Won’t Stay On The Shelf For Long”, OilPrice, November 2, 2015.)
With this kind of uncertainty, it’s hard to argue against the Bank of Canada’s unwillingness to engage in decisions over interest rates. Could the CAD-USD exchange rate hit $0.50 as a consequence? It’s certainly possible.