Negative Rates Could Hurt the Canadian Dollar
The Canadian dollar has endured a lot of pain recently, prompting the Bank of Canada to consider letting interest rates fall below zero. In doing so, Canada would join a handful of central banks (mostly European) in adopting negative interest rates, which, I should add, is a situation we’ve never seen before. What would this mean for the CAD to USD exchange rate? Nothing good.
The trend started in early 2015, when government bonds from countries like Denmark, Switzerland, and Germany dipped below zero. I understand that doesn’t sound like much to non-finance (non-nerdy) people, but it was major news in the business world. (Source: “Something economists thought was impossible is happening in Europe,” Vox.com, February 26, 2015.)
When a lender gives money to a borrower, it makes sense for them to expect a return in the form of interest payments. Until recently, economists thought that meant interest rates couldn’t possibly drop below zero, but obviously, they were wrong.
Negative interest rates mean that lenders are willing to pay borrowers to take their money. How ridiculous is that? The people giving out the loans are so desperate to keep their money safe that they’ll pay trustworthy governments for the privilege.
With oil prices in decline and Canada’s economy at risk of a recession, the Bank of Canada wants to push bond yields into negative territory as a way of tempting borrowers.
Central Banks and Currencies
Cutting interest rates has two general aims: to stimulate the economy through increased borrowing and consumption and to devalue the currency to boost exports.
If negative interest rates convince borrowers that it’s time to invest, then maybe that money gets cycled back into the economy, kick-starting a recovery across Canada. Of course, that is a distinct possibility, but it requires a crash in the Canadian dollar. (Source: “How negative interest rates could have a positive economic impact,” CBC, December 10, 2015.)
Under normal circumstances, negative interest rates would be painful, but not lethal to the Canadian dollar. However, there are other forces at work in the world that don’t suddenly stop because the Canadian economy is in trouble. Chief among these issues is the potential rate hike from the Federal Reserve.
America’s central bank has been keeping its interest rates at rock-bottom levels for seven years to stimulate its economy. Central banks all across the world have been doing it, but the U.S. was quick to act after the financial crisis, leading to a quick recovery.
Now the Federal Reserve is planning to restore interest rates to historical levels. Since lowering interest rates pushes down a currency, we can safely assume that raising interest rates will force the U.S. dollar to jump.
Weakened Canadian Dollar in 2016
To put it bluntly, the Canadian dollar outlook for 2016 is horrific. It faces the combined forces of a rising U.S. dollar and the possibility of negative interest rates at home, making it the perfect storm of Forex investing.
The “loonie” would have to fall a long, long way to make Canadian exports competitive. Oil was a major source of Canada’s national income when crude was above $100.00 a barrel, but the $35.00 price environment makes a recovery near impossible.
Overall, the United States and Canada seem to be moving in opposite directions; one is in recovery and the other is headed for collapse. Expect further declines in the Canadian dollar, folks.