Is the Loonie Leveling?

Canadian exporters are inquisitive. I personally hear a lot of your questions, mostly at conference Q&A sessions, but also through direct conversations. Without hesitation, the top issue is our dollar: why is it where it is at the moment, and where is it going. There are lots of other concerns too, but this one is critical because, no matter what’s being bought and sold, our currency is a key determinant of the price. Concern has been elevated lately because our dollar has been all over the map. Many have intimated stability is actually more important than the level of the loonie. Is it finally settling down, or is turbulence here to stay?

In just the past 6 years, the loonie has soared beyond parity with the US dollar, has dived to 68 cents, then back up to 79 cents before moving to the mid-to-upper 70-cent range. This is unusually volatile; movements like this are normally stretched over longer time periods. The heightened concerns of exporters are completely understandable. Contracts are struck and have to be honoured at discrete times; in a period of turbulence, the difference between rags and riches on any deal could be a number of days. Exporters have learned how to manage through a protracted period of currency strength; over and over I’m told that this is no longer the issue, but that the killer is volatility.

It follows that recent smoothing has been a big relief. After the early-year gyrations, our dollar has hovered in a reasonably tight band between US 75 and 78 cents. Twitchiness is still there, with the currency reacting to daily news, but for the most part, the movements have been comparatively modest. Can we expect this relative calm to persist?

There are many theories about day-to-day currency movements, and I’ve probably heard most of them. To track fluctuations, particularly in the choppy periods, we go back to the drivers we have found to be most influential over time. For the past 26 months, commodity prices have been a key mover. Don’t expect our currency to ever stand pat when commodity prices move as much as they did in the past two years. Most agree – and we are with them – that the commodity price plunge is now behind us, and that they are largely lined up with market fundamentals.

A second powerful influence is the difference in expected interest rates between Canada and the U.S. Quietness on this front added calm to the currency market over the summer, with most market-watchers ruling out a September hike by the Fed. To Canada-watchers, the weakness of exports together with fundamental weakness elsewhere in the economy pushed back any imminent moves by the Bank of Canada. Smooth sailing?

Not so fast. Quiet on the interest rate front was snapped last week, with speculation by Fed governors that an imminent rate hike was not off the table. Pressures have been building in the US economy for some time that could prove to be inflationary if the Fed doesn’t tighten. Analysts have been scanning monthly data for signs that would tip a rate decision, but the truth is that the Fed is having to see 12-18 months ahead as that’s roughly the time it takes a Fed action to have a noticeable impact on the real economy. Imminent rate action cannot be ruled out.

Also, while commodity prices seem to have hit bottom, they are inherently volatile. Recent rumours of talks between Russia and Saudi Arabia – the world’s top two producers – to curtail output were enough to jolt oil markets in the past few days. Add that to reports last week of considerably higher usage in the US, and suddenly the price bulls are out again. Other commodity markets haven’t been as active, but the lesson here is that it doesn’t really take much to get them going again.

Then there’s geopolitics. The shocking Brexit vote had an immediate impact on currencies. The morning after, markets bet heavily against the pound, and have remained negative since. The Euro came under fire, and though it gained back a lot of lost ground, remains vulnerable to developments on this very murky issue. Through this and other developments, the USD has maintained its status as a haven for worried investors.

The bottom line? Currency markets were calm over the summer months. Don’t get used to it; recent events show that volatility is still with us. Given the upcoming US election, the ongoing Brexit storm, post-recession structural vulnerabilities and the good chance that there will be one or two near-term surprises, best to be prepared for the loonie to see more ups and downs.

This has been written by Peter Hall, EDC Vice-President and Chief Economist.