Canadian Dollar Report—Keeping an Eye on the Loonie

After being stuck around 80 U.S. cents from November 2008 to April 2009, the Canadian dollar began a quick climb in May, eventually surpassing 90 cents. There were many factors at play that drove the dollar up. One was the general weakness of the U.S. currency. The British pound and the euro gained traction during the same time period. This situation supported the appreciation of the Canadian dollar. It continues to do so as the indexed rates are on an upward trend.

The easing of monetary policy by both the Federal Reserve and the Bank of Canada resulted in policy rates set at historical lows. This also caused interest rates along the yield curve to fall to all-time lows on both sides of the border. We expect the Bank of Canada to hold rates steady at their current levels into the first half of 2010, and thus interest-rate spreads will act only as a minor supporting role rather than a major contributor in terms of Canadian dollar movement. Although spreads are at their narrowest point for quite some time, they remain positive. This trend is giving the loonie some upward drift.

The rise in oil prices is the main driver behind the Canadian dollar's recent boost. Oil prices are now above US$70/barrel. The last time the Canadian dollar was over 90 U.S. cents, oil was around US$100/barrel. Based on the latest IHS Global Insight forecast for oil prices, which are expected to increase from current price levels, there is definite support to lift the loonie higher still.

There are many risks to the outlook of the Canadian dollar. IHS Global Insight believes that market fundamentals do not support the quick advance in oil prices, therefore some downward adjustment to prices is likely in the near term, posing some downside risks. Also, we continue to see safe-haven buying of the U.S. dollar as the recession risks loom on a global scale. This development is a negative for the Canadian dollar. Nevertheless, as global economies eventually emerge from recession, we are forecasting the Canadian dollar to steadily rise and stay above 90 U.S. cents as the prices of commodities increase, while interest-rate spreads are likely to stay positive and widen. We are not predicting the Canadian dollar to hit parity over our forecast horizon. It may hit parity again, but probably not for a sustainable period.