The loonie has fallen to its lowest level in almost two years – here’s why
The Canadian dollar fell to its lowest level in nearly two years on Friday as investors around the world reviewed the deteriorating outlook for the economy and raced to the safety of the U.S. dollar.
The Canadian dollar was changing hands for as low as 75.15 US cents at one point Friday morning. This is the currency’s lowest level since October 2020.
The loonie is down about half a cent from Thursday’s close, which is just the latest bearish day in a series for the Canadian currency. The loonie fell more than a cent on Tuesday as US data showed the country’s core inflation rate was still heading in the wrong direction: up.
One country’s currency doesn’t often dip because of economic data from another, but it doesn’t right now because of the magnitude of the inflation problem.
Stubbornly high inflation in the United States increases the chances that the country’s central bank will have to raise its interest rate even more aggressively than it has been. The US Federal Reserve is expected to do just that next week, raising its benchmark rate by at least 75 basis points to 3.25%, if not more.
Investment pricing pegged to the Fed rate suggests to investors that the US bank rate will eventually reach four or even five percent.
“Rates will peak higher than expected a few months ago and stay there longer than originally expected,” said Audrey Childe-Freeman, currency strategist at Bloomberg Intelligence. “At some point the market will focus on the next Fed cycle [of rate cuts] but it’s far.”
If the Fed rate goes to 4.5 next year, as investors expect, that’s a lot more than the Bank of Canada is likely to be able to do, which is why the spread between currencies of both countries widens.
How rate hikes affect a currency
All other things being equal, rate hikes increase the value of a country’s currency because it is more attractive for foreign investors to put their money there: they will get a higher return. This rule of thumb is even more applicable than usual right now, as the US dollar is considered the safest place to keep your money in times of uncertainty.
“There’s been an absolute flood of money into the US dollar because it’s the ultimate safe haven and because the US economy is much stronger than anywhere else,” says Adam Button, chief currency analyst at ForexLive.
The loonie appears to be taking a dip as just about anything other than a US dollar is hurting right now, he said. Compared to other currencies like the Euro, British Pound and Japanese Yen, the Canadian dollar has actually gained ground this year. But it’s falling by the yardstick by which most Canadians measure it: the US dollar.
Another reason for the loonie’s relative weakness is weak commodity prices like oil and gold as the outlook for the global economy deteriorates.
“Commodities are weak largely because the market is (finally) coming to terms with the fact that the outlook for global demand looks bleak,” said CIBC currency analyst Bipan Rai. “That counts for a key proxy like the Canadian dollar.”
The price of a barrel of oil has lost about $30 since June, which under normal circumstances would be enough on its own to lower the loonie.
But that selling pressure is compounded by what investors think central banks will do. While Canada’s central bank is also aggressively raising rates, pain in the country’s housing market and consumer spending will likely force the central bank to halt the hike soon.
“Until last week the market was saying both would stop at around 4%,” Button said. “Now the market is saying the Fed can go higher, but the Bank of Canada might not be able to.”
If that happens, it’s a recipe for even more money to be pumped into the US dollar, which is why Button wouldn’t be surprised to see the loonie dip below 73 cents by the end of the month. year.
“Canadians might not fully appreciate how bad things are,” he said.