It may not feel like it, but the Canadian dollar has quietly been the best-performing major currency in the world this year, up four percent since January.  

Canada’s currency was changing hands on July 29th at about 76 cents US, up about three cents from where it was in January. The economy is growing, at a faster pace than economists were expecting. The trade picture is improving, as Canadian businesses — believe it or not — are selling more to the world than ever before.  That’s leading to more hiring, and the job market is heating up, which is leading to higher wages for just about everyone.  By any reasonable metric, Canada’s economy is doing just fine. But currency projections are quite often based on what’s coming in the distance, not the picture in the rear-view mirror. 

Too good for too long?
CIBC currency strategist Bipan Rai says the Canadian economy has been over performing of late, as it revved up following a trough in late 2018 and into the early part of this year. He thinks Canada’s economy — and, by extension, the loonie — should be strong enough to stay in a stable range for the next little while. “But beyond that? Things look a little dicey,” he said in a recent note. A major dark cloud, he says, is the ongoing trade uncertainty. The two largest economies in the world are engaged in a trade war, one in which Canadians are already collateral damage.

Central bank decisions
A country’s currency is more or less a gauge of confidence in the economy, but the single biggest factor in setting the value of a dollar is often a country’s central bank policy. Central banks hike their benchmark interest rate when they want to cool down the economy, and they cut when they want to stimulate it. All things being equal, a rate hike makes a country’s currency stronger, while a cut makes it weaker. After the Bank of Canada’s latest policy meeting in July, Governor Stephen Poloz made it clear the central bank was quite content to sit on the sidelines for a while, and keep its rate right where it is while it watches the economic data trickle in.

But even though the economy is “returning to potential growth,” as Poloz put it, the bank is still worried about the trade outlook and oil prices enough that a rate change is on the table. “Don’t get us wrong,” Rai said, “We don’t think the bank should cut yet just based on the available evidence, but the risks clearly favour [a cut] rather than [a hike] going forward.”  A cut — even one that’s only skin-deep — could push the loonie lower. 

Waiting on the Fed
“Many currency watchers were waiting to see if the U.S. Federal Reserve would cut interest rates,” ATB Financial economist Todd Hirsch said in a recent note. On July 31, the Federal Reserve cut the upper range of its core lending rate, known as the federal funds rate, to 2.25%. This cut of 0.25% is the first cut since 2008 and according to Hirsch, “…this could push the value of the loonie up, at least in the short term.” “The Bank of Canada is definitely out of synch with the Fed,” Hirsch said in a recent note, “[and] despite the strong U.S.-Canada ties this divergence reflects the fact that the two countries are at different points in the economic cycle.”

He rejects the notion that Canada is bound to get walloped by a global trade war, citing recent research from none other than the Bank of Canada that suggests Canada’s economy could grow more than most in such a scenario. Add it all up and Korber sees a recipe for a stronger loonie through the rest of the year. “A summer move toward [80 cents] is possible,” he said.

Source: CBC
Source: CBC