Each day TFO Canada publishes a sample of trade news on the Canadian import market along with any new, updated or changed regulations and legislations regarding international trade; countries in which TFO Canada offers services and on the export sectors which it promotes.
Loonie at Par: Loony?Thursday, June 16, 2011 > 09:30:08
(Export Development Canada – Peter G. Hall)
Our spring Let’s Talk Exports roadshow wrapped up last week. Over the 15-city tour, one key concern was expressed without fail: the soaring Canadian dollar. Above par since January, the Northern buck has many believing it is stuck there. Has parity now become permanent, or is some relief on the way?
The loonie’s movements in recent years have mocked forecasters, and made pricing decisions and cash flow planning extremely difficult for exporters. Within a decade, our dollar has swung from USD 0.63 to USD 1.09, with recent fluctuations between USD 1.02 and USD 1.05. Even so, vibrant export performance last year and thus far in 2011 demonstrates the resilience and creativity of Canadian exporters. But this adaptability has its limits – if sustained, current levels could soon punish exports.
Current strength can be traced to four factors. Surging commodity prices are a primary driver. Supply worries and political turmoil in the Middle East have ignited oil prices, which in recent years have a 77% correlation with loonie movements. Scarcity, whether actual or imagined, has powered base metal prices. Food prices have soared, owing to depleted global inventories. If prices remain elevated, relief from the loonie’s current levels is unlikely.
Canada’s “halo effect” is also pushing the loonie skyward. Our sound banking system, well-managed public finances and solid domestic economy has elevated Canada to safe-haven status amid swirling concerns about sovereign debt crisis in Europe or economic weakness in the US. The result? A 47% surge in foreign portfolio investment in Canada since 2007, to CAD 731 billion by end-2010. Pressure has been augmented by the recent return of the current account to a surplus position.
Monetary policy is a third important driver. Investors are responding to a divergence in interest rates and inflationary expectations between the US and Canada. Since last September, the Bank of Canada’s overnight rate has risen to 1%, while the US Fed firmly maintains near-zero rates and is adding massive amounts of quantitative easing. The monetary base has now almost tripled in the US, feeding concerns that recovery could instantly detonate inflation. Weighing these concerns has generally favoured the loonie in recent trading activity.
A fourth influence is speculation. Evidence shows that hedge funds, exchange-traded funds and speculators can move commodity and currency markets in the short term. Recent CFTC reports show large net speculative positions shorting the USD against major currencies, notably our dollar.
Will all or part of this upward pressure unwind? Evidence of speculation suggests that oil and base metal prices will tumble in 2012. Economic uncertainty and a similar trajectory of monetary expansion suggest more aligned cross-border inflationary conditions. Increasing US momentum will weaken the glow of Canada’s halo. Long-run analysis suggests that a Canadian dollar is about 17% overvalued, and belongs in the 95-cent range. These factors ought eventually to cool the speculators.
The bottom line? Taking these drivers into account, EDC Economics is forecasting that the dollar will average USD 1.01 this year and slide to USD 0.98 in 2012. While this is needed respite for Canadian exporters, the path to a weaker loonie will likely be somewhat loony – prepare for near-term volatility.