By Peter G. Hall, Vice-President and Chief Economist, EDC

Recent Canadian dollar weakness has prompted requests for a reprint of EDC Economics current view of the currency. The loonie has soared in a reasonably tight range around parity with the US dollar for 3 years now. Although exporters would prefer a lower level, the stability has made activity and cash flows somewhat more predictable. Now, the loonie is losing some loft; what’s happening?

A decade ago, predictions that the Canadian currency would rise to 75 cents US seemed outlandish. Some firmly believed that we were headed for 50 cents, and that fixing the rate in the mid-60’s would be a good deal. No one foresaw the 8-9 per cent annual appreciations that blew past the ‘wackiest’ forecasts and for a time took the loonie well north of parity. After that run, few were expecting stability.

Not long ago, even fewer were expecting a drop in the dollar. After all, high commodity prices were only expected to rise more if and when the world economy ever recovered. Faster growth would also lead our interest rates north – and perhaps more rapidly than in the US. Many expected an ailing greenback to boost the loon, as ‘flight to quality’ plays ebbed. And then there’s Canada’s halo effect: our great financial, fiscal and natural resource conditions, with their magnetic pull on foreign capital.

Things haven’t quite worked out that way. A reviving world economy has revealed that we are not running out of resources at the pace many feared; in fact, in certain prominent cases like US shale oil and gas, resources are far more abundant than many dreamed. This has quieted speculative activity and brought prices down. Copper, the prescient metal, is down 17 per cent from its peak, and with it a lot of other base metals. Fuel prices have weakened considerably: oil has now been below the triple-digit zone for a year, and is 33 per cent below its peak. Food and forestry prices are bucking the trend, but all told, the weakness is weighing on our commodity-influenced currency.

In addition, interest rates may not boost the loonie much after all. Sure, Canada faces tight constraints going into the next growth cycle, but high consumer debt, a faltering housing market and public sector cutbacks will likely counter the need for rapid monetary tightening. Moreover, US rates are currently 88 basis points lower than ours, and have further to go to get to normal levels over the medium term – additional rationale for a softer Canadian dollar in the medium term.

And what of those who foresee a perpetually weak US dollar? Guess again. With some of the strongest economic fundamentals in the OECD, don’t count the US out as a global growth engine with a sought-after currency. In fact, the greenback has been on the positive side of currency wars that don’t seem likely to abate anytime soon. With exports being the great hope of OECD economies saddled with weak domestic fundamentals, tolerance for appreciating currencies is low. Slow appreciation is a very likely outcome for the greenback, which will further weigh on the loonie.

Finally, there’s the halo effect – which has lost some shine in recent days. High-profile laments of Canada’s domestic weakness are causing international investors to pause and reflect, in spite of the promise of significant resource investment. Near-term challenges on the home front will likely continue to temper enthusiasm for the loonie, causing it to drift closer to its fundamental value.

The bottom line? The Canadian dollar’s recent downward drift makes sense. From our forecast of US97 cents this year and 96 cents next, it looks like its medium-term home will be at the mid- to high- 90-cent level – possibly lower. It’s just in time for a ‘growth handoff’ to Canadian exporters!

This commentary is reprinted with permission from EDC. It is presented for informational purposes only. It is not intended to be a comprehensive or detailed statement on any subject and no representations or warranties, express or implied, are made as to its accuracy, timeliness or completeness. Nothing in this commentary is intended to provide financial, legal, accounting or tax advice nor should it be relied upon. Neither EDC nor the author is liable whatsoever for any loss or damage caused by, or resulting from, any use of or any inaccuracies, errors or omissions in the information provided.