Loonie watch: Sub-70 cent Canadian dollar inching closer into view

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The Canadian dollar sank below 71 cents U.S. Friday for the first time since mid-2020, breaching a level that some analysts see as a “psychological barrier” and bringing a sub-70 cent loonie closer into view.

Friday’s drop came after United States Federal Reserve chair Jerome Powell hinted that a December interest rate cut is no longer a given, setting up a scenario for a wider interest rate differential between the U.S. dollar and its Canadian counterpart.

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The Canadian dollar fell as low as 70.89 cents U.S., lingering below 71 cents U.S. for most of the afternoon on Friday.

“The biggest catalyst this year to the weaker dollar is the divergence in monetary policy,” said Earl Davis, head of fixed income and money markets at BMO Global Asset Management.

While the Fed decides whether to hold off on another interest rate cut this year, the markets are weighing whether the Bank of Canada will cut rates by 25 or 50 basis points when policymakers next meet on Dec. 11.

A hundred basis point difference makes the U.S. dollar that much more attractive to investors.

“The natural tendency is … you put (money) in the country that has the higher interest rate because you are going to earn a higher return on that,” Davis said.

Interest rates aside, Davis said there are “fundamental reasons” behind the Canadian dollar’s nosedive. (Since the end of September, it is down 4.7 per cent.)

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There’s a born-in-Canada reason why we are having a weaker economy

Earl Davis

Among those fundamentals is housing. In Canada, homeowners will be renewing their mortgages at higher rates this year and over the next two years.

“When mortgage payments go up that’s (money) you can’t spend for food, for restaurants, for goods, for services,” Davis said. “Your GDP goes down because there is less consumer spending. The U.S. doesn’t have this impact,” he said, noting that the U.S. has 30-year mortgages, as opposed to five-year contracts in Canada, meaning homeowners there are locked in at hyper-low pandemic rates.

“There’s a born-in-Canada reason why we are having a weaker economy,” Davis said.

He also thinks U.S. president-elect Donald Trump‘s “nationalistic policies” on lower regulation, taxes and tariffs are already drawing investment to the U.S.

For evidence, Davis pointed to the U.S. dollar index, which measures the greenback against a basket of major currencies including the Canadian dollar.

The index has been on a tear since the end of September when Trump’s polling numbers started to improve. It’s currently up six per cent since then and Davis thinks it will continue to climb to the highs of the fall of 2022.

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“Because it’s a policy change I suspect the dollar is going to gain more and more strength.”

Looking ahead to a weaker Canadian dollar, Davis doesn’t think it’s necessarily a bad thing, suggesting a lower loonie could benefit Canadian business as goods become cheaper for their U.S. counterparts.

On the flip side, there exists the chance of inflation for the Canadian consumer as U.S. goods become more costly.

But Davis thinks there is room for inflation to fluctuate given that it grew at a rate of 1.6 per cent year over year in October and the Bank of Canada’s target range is one per cent to three per cent.

“This gives the Bank of Canada comfort to say yes we may import some inflation here, but that brings us up to two per cent. We are at target,” he said. “All in all, we are in a good position to continue with lower interest rates for Canada and Canadians, which will have both positive and negative implications, but much more positive implications.”

Those include include boosting exports, adding employment and tax revenue, and expanding GDP.

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