We recently read an interesting commentary on the Canadian dollar by Dagmara Fijalkowski of RBC Global Asset Management. It highlighted some interesting points.
In just three months, the Canadian dollar appreciated approximately 10%, an uncommon feat that will impact the pocketbooks of all Canadians.
In June, the Bank of Canada predicted stronger economic growth and adjusted monetary policy to match, raising its key interest rate for the first time in seven years, to 0.75%. The market took notice, especially when the United States Federal Reserve chose to instead focus on its balance sheet.
Almost overnight, the Canadian dollar became less tied to the simple cost of a barrel of oil and instead began to reflect this new optimism from the Bank of Canada. The short-term correlation between the Canadian dollar and oil dropped by more than half, to 25% from 56%, while the correlation with two-year interest rate differentials soared from 30% to 72%.
The Bank of Canada expects these conditions to encourage exports and corporate investment, though they acknowledge consumer contribution to growth will weaken. Others, including the Royal Bank of Canada, disagree for a variety of reasons:
- Real estate prices may drop, especially as a result of increased regulation, higher interest rates, and lower affordability even for foreign buyers.
- The United States’ central bank balance sheet is expected soon and may strengthen their dollar in relation to ours.
- A stronger Canadian dollar and new interprovincial trade agreements may keep inflation lower than the Bank of Canada expects.
- The impact of competitive advantages in the United States in areas such as taxes and labour costs.
- A large current account deficit will require foreign funding.
- Consumer debt remains high and may limit future contribution to growth.
It’s impossible to say for certain if the loonie will continue to flex its muscle, but this latest rally is already providing good opportunities in both the medium and long term.
