We doubt the Canadian dollar’s resilience will last much longer
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We doubt the Canadian dollar’s resilience will last much longer

The Canadian dollar has held up relatively well against the US dollar so far in 2022, but we think the factors underpinning the loonie’s resilience will fade and push it lower against the greenback over the next couple of years. In view of the wider interest, we are also sending this FX Markets Update to clients of our Canada Service. 
  • The Canadian dollar has held up relatively well against the US dollar so far in 2022, but we think the factors underpinning the loonie’s resilience will fade and push it lower against the greenback over the next couple of years.
  • The loonie has been the best-performing G10 currency against the US dollar so far this year. (See Chart 1.) In our view, this has been largely due to elevated commodity prices and a relatively hawkish monetary policy stance, but we expect these tailwinds (and the loonie) to weaken before long, for three reasons.
  • First, we think that the prices of most commodities will fall a bit further on net over the next couple of years. Admittedly, the loonie remains weaker than the level implied by Canada’s current commodity terms of trade. (See Chart 2.) But we doubt that it will rebound as commodity prices falter. What’s more, the outlook for the volume of exports looks challenging as economic growth in the US – Canada’s largest export market – and the rest of the world continues to slow. And falls in US economic activity have usually coincided with weakness in the loonie relative to the US dollar. (See Chart 3.)
  • Second, although we don’t expect a recession in either economy, we think that the downturn in economic activity will be deeper and more prolonged in Canada than the US. To a large extent, this is because of vulnerabilities in Canada’s housing sector, which is more sensitive to rising interest rates and is a larger share of economic activity than the housing sector in the US.
  • Third, we expect the Bank of Canada to reverse its rate hikes by a bit more than investors currently anticipate in 2023, in part due to our outlook for housing. (See Chart 4.) By contrast, we think the Fed will hike further and reduce rates more slowly than investors discount. Taken together, this suggests to us that interest rate differentials are likely to shift in favour of the greenback over the coming quarters.
  • The upshot is that we forecast that the loonie will fall to 1.35/$ by end-2022 and 1.40/$ by end-2023, from around 1.27/$ at the time of writing.

Chart 1: YTD Changes Vs USD (%)

Chart 2: Canada Commodity Terms of Trade (CToT) Index (2010 = 100) & USD/CAD

Chart 3: USD/CAD & OECD Leading Economic Indicator (LEI) For The US

Chart 4: Canada Policy Rate (%)

Sources: Refinitiv, Bloomberg, Capital Economics


Jonathan Petersen, Senior Markets Economist, jonathan.petersen@capitaleconomics.com

Jonathan Petersen Markets Economist
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