Catching Up with the Greenback

Not too long ago, Americans would arrive in Canada by the boatload looking to take advantage of a cheap Canadian dollar. But that was then and this is now. Today, things have changed, and the Canadian dollar, the “loonie” as it is often referred to, has been taking advantage of a strong upward tailwind. The cash price of the loonie traded as high as US$0.8382 on August 12 before the subsequent drop.

 In fact, at one point decades ago in the `70s, the loonie traded higher than the U.S. dollar. And now, given the rally in the loonie, we are again beginning to hear whispers of a much higher loonie. I have heard very optimistic targets calling for the loonie to touch US$0.90. You may think this is a pipe dream, but there is a chance the loonie could rally to $0.90. But then,  everything would have to fall in place. I will explain.

 Since mid-May, the loonie has been on a strong upward trend and may be set to take out US$0.84 if the upward sloping trendline remains intact. In fact, the loonie is currently trading at its highest level in over 10 years. Consider the fact that as recent as mid-2002, the loonie was struggling at US$0.625. That is a gain of 34%. So what gives?

 Rising commodity prices such as gold, copper, and oil initially triggered the rapid acceleration in the loonie. The loonie has always been known as a commodity-based currency. Its relatively close correlation with commodities is clearly giving the currency some lift.

 The loonie also had an advantage as short-term interest rates in Canada were significantly higher than in the U.S., but with 10 straight increases in the Fed Funds rate, short-term interest rates in the U.S. have edged higher — today, the interest rate differential is narrowing between Canada and the U.S. The Bank of Canada has not increased interest rates in about a year, but there have been indications from the central bank that rates will be increasing in the near term. In principle, capital tends to flow from low-yielding countries to higher-yielding countries given that everything else is the same.

 I think if the loonie can hold at $0.83 and if all factors fall into place, then a US$0.90 loonie is within reason. The outlook for the loonie remains positive as long as oil and commodity prices stay high. But if U.S. rates continue to edge higher and inflation surfaces, we could see increased selling of the loonie in favor of the greenback. And if oil and other key commodities begin to pull back, it could spell the end of the loonie’s attempt to take out US$0.90.