As Canada Props Economy, Loonie Gathers Fragile Strength - Kalkine Media

August 03, 2020 11:00 PM AEST | By Team Kalkine Media
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  • The Canadian dollar touched a three-year low against the US dollar in March as the pandemic decimated markets
  • The currency is gently gaining grounds, with loonie trading at 0.74x times the US dollar by end of second quarter
  • Canada’s burgeoning forex reserves, recovery in oil prices and return of inflation to a positive territory are supporting its dollar’s recovery

Last five months have been a struggle for the Canadian economy – from economic recession, credit slowdown, rising fiscal deficit to negative inflation and job losses. All triggered by the coronavirus pandemic that has stopped the march of humans and economies the world over.

However, most economic indicators are showing signs of improvement with month-on-month gains (since April or May). But the figures are nowhere near the pre-pandemic levels. Wait till 2022 for complete rebound, says the Canadian central bank.

And amid all this, is the slow tango between the loonie and the greenback currency pair since March 19, 2020.

Canadian Dollar-US Dollar Year-to-Date Chart

(Source: TSX)

After touching a three-year low against the US dollar in March, the Canadian dollar has been gently but steadily gaining grounds.

The loonie, currently an outlier in the commodity currency markets, has demonstrated unusual strength. Riding on the back of strong commodity prices, near-zero interest rates, market’s risk appetite and infusion of capital pumped in through quantitative easing (QE), the loonie was trading at 0.74x against the US dollar at the end of second quarter, as compared to 0.69x during the March financial market crash.

Though July was a mixed month for the Canadian Dollar, it continues to be one of better-performing major currencies of the world since the pandemic-triggered stock market crash.

The Strengthening Loonie

Over the last four months, the Canadian dollar’s rise has been supported by a variety of factors that led to its display of strength.

At the outset is the price of oil, one of Canada’s major exports. Following historical falls, the oil recovered after OPEC+ announced emergency crude production cuts in April to shore up the prices. Crude oil accounts for a large portion of US dollars earned by Canada, and this rebound in prices resulted in appreciation of the value of Canadian dollar.

The Canadian economy’s slow rebound is another factor. Immediately after the pandemic-led market crash, the country’s economy shrank almost 12 percent in historic contraction in April – the deepest downturn since the Great Depression of 1930s. However, the GDP figures improved in May, growing 4.5 percent, according to Statistics Canada. Flash estimates suggest the economy may have grown by 5 percent in June.

The country’s rising inflation also helped the Canadian dollar remain on sturdy ground. The inflation returned to positive territory after the Consumer Price Index (CPI) grew 0.7 percent year-over-year in June. It had turned negative in April over declining consumer expenditure following the enforcement of strict lockdown measures to curb the spread of coronavirus pandemic.

Also affecting foreign exchange (forex) is the national interest rate (that has a direct correlation to inflation). The Bank of Canada has kept its benchmark interest rate near zero since March this year, until the “two percent inflation target is sustainably achieved”. The benchmark interest rate has been at 0.25 percent in an effort to stabilize the national economy, forex market and inflation.

There has been decent activity on foreign capital inflows too. Canada has been able to attract record C$ 49 billion foreign capital to securities during the pandemic, which led to forex appreciation.

Canada’s forex reserve currently stands at USD 87.2 billion, after burning USD 95 million in June to support the currency during the pandemic crisis. Analysts expect further decline in the forex reserves by the end of 2020.

Canada Foreign Exchange Reserves ( $ million)

Meanwhile, the market consensus turned negative for the greenback, over US’ surging COVID-19 cases, growing unemployment and delay in fiscal stimulus package. The US is Canada’s largest trading partner, accounting for nearly 63 percent of bilateral merchandise trade in 2019, as per Statistics Canada data. Uncertain US economic outlook will drag its dollar lower against the loonie.

Other factors directly or indirectly affecting the Canadian dollar include employment rate and job, consumer spending, international trade and political stability.

Future Projections

As the pandemic rages on, the forex will continue to be impacted by a host of reasons.

First and foremost is the C$343-billion budget deficit accrued by Canada over federal expenditure on coronavirus support programs. This will impact the country’s inflation, forex reserves and interest rates, which in turn will create a negative impact on the two-nation currency charts.

Weak global commodity demands, including low oil prices, low GDP, high national debt, souring market risk sentiment, dependence on foreign investments for budget and current-account deficits, can also drag the loonie down.

However, a variety of direct and indirect factors come into play and the exchange rates are ultimately decided by the dominating effect.


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