It wasn’t that long ago when the Canadian dollar was on par with the U.S. dollar. Fast-forward a couple of years and the CAD to USD exchange rate is having its biggest annual loss since, well, ever. In the last few weeks though, the “loonie” has been climbing upward. Some analysts are even saying that the worst is over for the Canadian dollar.
But is the worst really over?
Bearish Outlook for the Canadian Dollar
Canada has great landscapes, great resources, and great people. But under today’s macro environment, the Canadian dollar is not really a match for the greenback.
First, there are the fundamentals. Comparing two countries’ economies at a static point in time does not really give you much insight as to where their exchange rate is going. However, if you look at the growth paths of the two economies, you might get some idea on the future supply and demand dynamics of their currencies.
Exports and imports have strong ties to exchange rates. When you buy something from another country, you might need to settle the deal in their currency. If you buy more from your trading partner, the quantity demanded for their currency goes up.
Canada’s economy has a substantial export sector. According to data from the World Bank, exports of goods and services make up more than 30% of Canada’s gross domestic product (GDP). (Source: “Exports of Goods and Services,” The World Bank, last accessed February 26, 2016.)
Now, want to take a guess at what Canada’s top export is? Yep, it’s oil. And the downturn in oil prices is dragging down the CAD-USD exchange rate in at least two different ways.
First, lower oil prices means buyers don’t have to pay as much as before to get the same amount of oil. With Canada exporting more than 3.1 million barrels of crude oil to the U.S. per day, the huge tumble in oil prices is putting a lot of downward pressure on the CAD/USD exchange rate. (Source: “Company Level Imports,” U.S. Energy Information Administration, January 29, 2015.)
At the same time, the oil industry in Canada is also taking a hit. Several oil companies in Canada have had massive layoffs. Moreover, the declining value of Canada’s number one export is also dragging down the country’s GDP growth.
For those who think oil prices are about to go up and all will be rosy for the Canadian dollar, here’s a fact to consider: for the price of the commodity to go from $90.00 to $30.00, it takes a 66.7% drop, but for the price to go from $30.00 to $90.00 again, it would need to see a 200% increase.
Let’s not forget what central bankers are thinking of doing these days. You might not find explanations in your economics textbook, because it’s really an anomaly. I’m talking about negative interest rate policies. To put it simply, a central bank will charge commercial banks interest rates to park money with it.
With economic growth slowing down around the world, many policymakers are thinking of adopting negative interest rates. In fact, the Bank of Japan (BoJ) and the European Central Bank (ECB) are already implementing a negative interest rate policy.
Facing strong growth headwinds, the Bank of Canada might follow in the footsteps of the BoJ and ECB and set a negative benchmark rate in Canada. The U.S. Federal Reserve, on the other hand, might do the exact opposite. On Wednesday, Richmond Fed President Jeffrey Lacker said that strong growth in the U.S. jobs market could justify several rate hikes this year. (Source: “Fed: Strong U.S. Job Market May Justify Multiple Interest Rate Increases This Year,” The Guardian, February 24, 2016.)
The Bottom Line on the CAD/USD Exchange Rate
There you have it. Oil prices are still down and central bankers might pursue different policies. The outlook remains bleak for the Canadian dollar.