The Loonie’s Bumpy Ride
Suddenly, cross-border shopping isn’t as much fun as before and a Sunbelt vacation has become more expensive. Blame it on the diving loonie.
At the start of the year, our dollar was trading at about half a cent above parity. Now it is struggling to stay above US$0.97, trading at the time of writing at US$0.973. That’s a drop of more than 3 per cent in just 10 weeks. Since hitting its 2012 high of US$1.0371 on Sept. 14, the loonie has tumbled by US$0.064, a drop in value of 6.2 per cent.
And there may be more downside to come. A report issued by National Bank Financial this month predicts the Canadian dollar will be trading in the US$0.95 range by the third quarter of the year and suggests it could possibly go even lower. The bank had previously predicted a slide in the loonie but now says it is happening faster than expected.
National Bank analysts Stéfane Marion and Krishen Rangasamy cite several reasons for the surge in the U.S. dollar, which is coming off its best month since last May, and the corresponding fall in our currency. These include new political turmoil in Europe as a result of the hung Italian election and renewed concerns for global growth following the failure of the U.S. Congress to head off sequestration, thus triggering US$85 billion in automatic spending cuts.
International investors are again turning to the greenback as a safe haven in the absence of any viable alternative. Japan’s new government and the Bank of Japan are pursuing policies that are devaluing the yen. These include an aggressive program of quantitative easing that National Bank predicts will drive the yen down to 100 per U.S. dollar by year-end. One American dollar currently buys about ¥95.
In Europe, the euro is again under downward pressure as the continent deals with an economic contraction and unemployment levels that are dangerously high in the southern tier countries. “The path of least resistance for the euro is downwards,” the analysts write. They forecast a mid-year valuation of US$1.23, a decline of more than 5 per cent from current levels.
As for the British pound, it has been in free-fall against the greenback. At the start of the year, it took almost US$1.63 to buy a single pound sterling, now the rate is down to about US$1.50 and still sliding.
No wonder global investors are piling into the greenback again. There’s nowhere else to go. Switzerland had been a favourite alternative. But the country’s second-largest bank, Credit Suisse, announced in December it would impose negative interest rates on foreign investors holding balances in Swiss francs as a move to discourage capital inflows that have pushed the value of the franc to almost US$0.95. In other words, you have to pay them to hold your money.
So why not the loonie? Why isn’t our currency also benefitting from the safe haven mania? Our interest rates may be low but they are not negative, and in fact they’re higher than U.S. rates for short-term deposits. Plus we have one of the few national AAA ratings left.
Unfortunately (or fortunately if you are an advocate of a cheaper loonie) there are several factors working again us. For starters, the world continues to view the loonie as a petro-currency, rightly or wrongly. With our oil patch in a heap of trouble, that works against us. Our weak economic growth rate is another factor. Then there’s the Bank of Canada’s perceived new dovish position on interest rates which suggests that we won’t see any move off the current 1 per cent overnight rate until at least the second half of 2014. Taking all this into account, the National Bank analysts do not see the loonie regaining parity for the foreseeable future.
One investment conclusion that we can draw from the National Bank outlook is that U.S. stocks look more attractive than ever. Not only does Wall Street offer greater capital gains potential than the TSX under current conditions but there is also the possibility of enhancing your profits through currency gains. Any U.S. stocks that you own are already ahead 3.2 per cent in Canadian dollar terms this year even if their market price has stayed flat, thanks to the rise of the greenback against the loonie. Any further decline in the Canadian dollar will only add to your gains.
For fund investors, this raises the question of whether to use ETFs and mutual funds that employ currency hedging. When the Canadian dollar is rising, such strategies work in your favour. Unhedged investments in U.S. securities lose value when the greenback depreciates, which is partly why American stocks performed so badly in Canadian dollar terms in the first decade of this century. But when the U.S. dollar rises, the converse is true. If you have significant assets in hedged U.S. funds, you may want to reconsider your position in the light of the National Bank forecast.
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