This article appears as published in the Globe and Mail.
Canada’s weather this winter has been erratic with snow, rain, sleet and frigid temperatures. With the Canadian dollar floating around 75 US cents right now, you could say that it’s been a few years of rough weather for the loonie since it hit US$1.05 in 2011.
However, toward the end of last year, my team and I became more positive on the prospects for the Canadian dollar. Let me explain why.
With raised levels of global economic uncertainty, 2018 ended with more questions than answers. In particular, the growth paths of China and the euro zone, two of the three pillars of the global economy, remain uncertain. The third pillar, the U.S. economy, is still robust, but as I pointed out in my last article, is expected to slow in 2019.
In comparison, the Canadian economic outlook remains quite good and the growth path is more certain. Growth in 2019 is in line with the economy’s long-term potential and what’s more revealing is that there is less dispersion among forecasts than any other Group of 10 currency.
We did see the Bank of Canada revise 2019 growth downward in its January Monetary Policy Report – not surprising given recent market volatility and the aforementioned uncertainty – but the 2020 forecast was revised upward. With the U.S. economy likely to slow through 2020, this relative pickup in growth could give the loonie a boost later this year.
Great news for savers and another positive sign – for the first time since the global financial crisis, we will likely see short-term interest rates rise above inflation in 2019, at least in North America. This is an important reminder that we are still recovering from the worst financial calamity since the Great Depression.
Separately, oil prices have stabilized somewhat after global supply concerns and the potential ramifications of Iran sanctions proved excessive. We view oil prices as range bound going forward, staying between the marginal cost of U.S. shale production and the cap set by a semi-compliant OPEC 2.0 arrangement. That being said, near-term geopolitical risks remain elevated, so we believe commodities will be modestly supportive of the Canadian dollar over all, despite continuing transport challenges.
Even from a secular perspective, which admittedly has less influence on currencies in the near term, the Canadian dollar is undervalued relative to the U.S. dollar in our modelling.
What could make this seemingly rosy outlook for the Canadian dollar go sideways? There are a few scenarios that could see the U.S. dollar remain at its current level relative to the loonie. For this, we need to revisit the pillars of the global economy.
First, the carry forward of strength we saw in the December U.S. jobs report combined with a calming of financial market conditions could give the U.S. Federal Reserve the impetus to return to a more hawkish stance.
Next, an extended slowdown in China and the euro zone could see an increased flow to the U.S. dollar, the world’s reserve currency, in search of liquidity and safety.
All things considered, there appears to be a few tailwinds supporting the loonie here in the early part of 2019. Our economic growth is still above potential, the growth path appears more certain, and oil prices have bounced back from late 2018 woes. Perhaps conditions are just right for a thawing of the Canadian dollar.