Strategy

Canadian dollar: Loonie tunes

When will the dollar rise again?

Manufacturers that have struggled with a high Canadian dollar this past year might have one less thing to worry about: dollar parity could be a long way off. The loonie plummeted recently as the U.S. financial crisis threw global markets into turmoil. It traded at just under 97¢ in late September, but has since plunged 12.4% as of Oct. 15.

In some ways, the weakening of the Canadian dollar against its U.S. counterpart seems odd — analysts at CIBC World Markets referred to exchange rate fluctuations as the “dollar mystery” in a recent report. Indeed, the fundamentals of the U.S. economy are not great, and it is just inches away from a recession next year, according to the International Monetary Fund. If ever there was a safe haven at a time like this, shouldn’t it be Canada? After all, its financial system is in far better shape than those in the U.S. and many European countries. The IMF pegged the Canadian economy to grow by 1.2% next year, while the U.S. and the eurozone will grow by only 0.1% and 0.2%, respectively.

The greenback rally has not been primarily driven by faith in America’s fundamentals, however. “It had nothing to do with whether people were optimistic about the U.S. economy,” says David Watt, senior currency strategist with RBC Capital Markets. “It’s a structural demand. There were just not enough U.S. dollars available.” Watt says many banks around the world fund operations in U.S. dollars, and U.S. non-financial corporations have been repatriating greenbacks from subsidiaries abroad to shore up balance sheets and fund operations. Yet, to a lesser extent, there is still a perception of the U.S. dollar as a solid bet, Watt says. “Where do you want to sit to ride out this crisis? Most people are choosing the deepest and most liquid market in the world, because almost every other asset seems toxic.”

But the strength of the greenback may not be sustainable. As the U.S. economy slows and the fiscal deficit grows as a result of bailing out the financial sector, investors will focus on fundamentals, according to Shaun Osborne, chief currency strategist with TD Bank Financial Group. The loonie could see a boost as the greenback weakens — but not much. “The reality is, it’s not a natural safe haven for investors,” Osborne says. “Canada is still a small market.” The loonie is heavily tied to commodity prices, particularly of oil, which will likely stay low through a downturn.

Michael Gregory, senior economist at BMO Nesbitt Burns, says parity could be five years away. “We’re going to have to see a hefty rise in commodity prices, and I don’t think we’re going to get the global growth outcome over the next few years to generate that,” he says. There is also a perception Canada isn’t the oasis it was once thought to be — a belief driven by recent moves from the federal government and Bank of Canada to ensure stability in the financial sector. “Even though we’re in better shape than the U.S., the perception isn’t as positive as before,” Gregory says.

But if the global economy is headed for a cyclical downturn, growth could start again toward the end of 2009 and into 2010. Oilsands production will begin to pick up steam, even as supplies from other nations will be drying up. That means gains for the loonie. “What we’ve seen so far with regard to the Canadian dollar being a petro-currency,” Watt says, “is nothing compared to what it’s going to be.”