Catalysts That Could Make or Break the Canadian Dollar’s Rebound


The Canadian dollar’s rebound has started to waver.

The prospect of a slowdown in the economic recovery and the risk of a second wave of Covid-19 has hurt the loonie of late. Oil’s weakness is also a factor in the currency’s 1.1% drop against the greenback this month.

The loonie is among the worst-performing Group of 10 currencies this year: only the Brexit-ensnared British pound and the Norwegian Krone have done worse versus the U.S. dollar.

Catalysts That Could Make or Break the Canadian Dollar’s Rebound

More volatility is likely ahead, strategists say, because of four factors -- including politics.

The 2% Target

For Moneycorp US Inc. strategist Stephan Kulchyk, the Bank of Canada’s policy statement on Wednesday presented a more hawkish tone, providing some impetus for the Canadian dollar to strengthen.

The central bank’s targeted inflation rate of 2% could be a tailwind for the currency, as the Federal Reserve shifts to a different framework of average inflation targeting. (Governor Tiff Macklem said in a briefing Thursday that average inflation targeting is an interesting evolution that the Bank of Canada will be examining,)

“If the Bank of Canada keeps the current targeted inflation, they will be tightening faster than the Fed, with all else being equal,” Kulchyk said by phone. “That will provide a boost to the loonie in the medium to long term.”

In its policy statement released Wednesday, the central bank held the benchmark rate at 0.25% and said it will leave it unchanged until economic slack is absorbed so that the 2% inflation target is “sustainably achieved.”

If the loonie starts to get too strong, Macklem could always try to talk it back down. “The BOC could use the threat of ramping up QE to effectively soothe the traction seen in FX markets should the loonie take another leg higher,” said Simon Harvey, FX analyst at Monex Europe and Monex Canada.

Oil Prices

With interest rates staying lower for longer, Philip Petursson says oil prices will continue to influence the Canadian dollar.

“My view is that we still see the Canadian dollar strengthen against the U.S. dollar,” Petursson, chief investment strategist at Manulife Investment Management, said by phone.

Setting aside the supply and demand implications to oil prices, Petursson said U.S. monetary policy could be a key driver of where the U.S. dollar goes relative to commodities and, in turn, impact the loonie as a result. While oil prices could be facing some of its worst months historically this fall, Petursson is bullish on the commodity in the longer term. He expects the U.S. dollar to depreciate and crude prices to rise to as high as $50 per barrel over the next six to 12 months.

“While the Bank of Canada has committed to at least C$5 billion in bond buying per week, that I think will pale in comparison to what the Fed could do. Our fiscal policy, meaning deficit spending, is going to be less proportionately to GDP that what I think the U.S. could do.”

The Biden Factor

For oil to have a big impact on the loonie, of course, Canada has to be able to sell and ship a lot of crude at attractive prices. That could be harder if Joe Biden wins the U.S. presidential election.

“When it comes to most currencies, we’re not so concerned with the election outcome,” said Bipan Rai, FX strategist at CIBC. “But for USD/CAD, there is some risk with Biden winning given his views on terminating the Keystone XL pipeline.”

Biden, who is seen as less pro-oil than Donald Trump, has threatened to rip up permits for the Keystone XL oil pipeline project even as he courts blue-collar workers during his campaign.

“That would put pressure on the WTI-WCS spread and lead to a USD/CAD rally, so loonie watchers should keep their eyes on whether Biden stays consistent on that message,” Rai said.

More Stimulus

Kulchyk is also keeping an eye on Prime Minister Justin Trudeau’s new agenda, which he plans to introduce at the reopening of parliament on Sept. 23.

“I think it’s really going to be a huge story for the Canadian dollar and what this next fiscal stimulus plan looks like, especially now that Canada’s debt levels approach the $1 trillion mark for the first time in history,” Kulchyk said.

After appointing Chrystia Freeland as Finance Minister, Trudeau isn’t in any rush to reverse the kind of spending that has already driven the nation’s budget gap to 16% of economic output this year -- the highest deficit since World War II.

“It seems like this move to the left as far as Freeland coming in as Finance Minister, should help support Canadians at this time. But it still remains to be seen.”

©2020 Bloomberg L.P.

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