Let’s get right to it: the Canadian dollar faces serious headwinds—largely due to lower oil prices and a weakening economy. My forecast for the Canadian dollar in 2015 calls for continued weakness and potential for further downside.
Canadian Dollar Outlook 2015: The Technical Take
How times have changed. During April 2011, the Canadian dollar was worth as much as approximately USD$1.06. Over the ensuing years, a slowly improving U.S. economy coupled with slumping oil prices has seen a reversal of fortune for the Canadian currency.
Since 2010, the Canadian dollar has averaged $0.97 to one U.S. dollar. At $0.79 to the greenback, the Canadian dollar sits at support levels last seen in the midst of the Great Recession. These are strong support levels. In fact, TD Bank forecasts the Canadian dollar, otherwise known as the “loonie,” will only decline a few percentage points from its current levels—about four percent. (Source: TD Banking Group, February 27, 2015.)
But I would not be shocked to see these forecasts revised lower, as they often are. From a technical perspective, if the current level breaks, the next support level isn’t until the 2002 lows—about 21% lower from the current trading level (around $0.62 to one U.S. dollar).
The Impact of Oil Prices on the Canadian Dollar
A major concern on my mind is the price of oil. It plays a huge part in the direction of the Canadian economy and the gauge of its strength, the Canadian dollar. Just look at the chart below; it plots the Canadian dollar in red and crude oil prices in green. The correlation between the two is extremely high.
Chart courtesy of www.StockCharts.com
To give you some idea about how much of a role oil plays in determining the Canadian economy’s strength: the mining industry, including oil and gas, makes up 8.3% of Canada’s gross domestic product (GDP). (Source: Statistics Canada web site, last accessed March 13, 2015.) As a percentage of exports, crude oil accounts for a whopping 17%. (Source: Canadian Association of Petroleum Producers web site, last accessed March 13, 2015.) No matter how you slice it, oil prices matter, and it doesn’t look like they are rebounding anytime soon.
Further Headwinds for the Canadian Dollar
As the slump in oil prices continues, the Canadian economy seems to be slowing down as well, and the Bank of Canada is worried.
Back in January, the Bank of Canada surprised the markets when it lowered its benchmark interest rate from one percent (where it had been pegged since September 2010) to 0.75%. (Source: Bank of Canada web site, last accessed March 16, 2015.) While the central bank did not take further action at its latest policy meeting, more interest rate cuts are not out of the question at the next gathering on April 15.
Lower interest rates lead to a lower currency value. So, too, do an overpriced Canadian housing market and an increasing trade deficit.
According to the Bank of Canada, the Canadian housing market is overvalued by as much as 30%. (Source: The Globe and Mail web site, last accessed March 16, 2015.) In January, Canada’s trade deficit reached $2.5 billion, lead by a 15% decline in energy products.
Taken collectively, the Canadian dollar doesn’t seem so strong anymore—like it was only a few years ago.
Where Will the Loonie Go Next?
Pundits are often quick to point out that currency devaluation helps a country export its now cheaper goods. I only agree with this theory to a certain point. Understand this: Canada relies heavily on oil, and with oil prices declining, its export won’t look so great.
The Canadian economy is looking very fragile as well. This adds more pressure to the Loonie.
Saying the very least, investors should continue to stay cautious in 2015 when looking at the Canadian dollar, as the worst may be yet to come.