What’s up with the soaring loonie?

The loonie’s rise is creating headaches for the Bank of Canada

Brent Lewin/Bloomberg via Getty Images

Brent Lewin/Bloomberg via Getty Images

This post originally appeared at BusinessInCanada.com

The Canadian dollar is on a tear.

After a surprisingly firm inflation print for May brought the headline rate above the midpoint of the Bank of Canada’s target range, and manufacturing data from China beat expectations, the loonie is trading at about 0.932 against the greenback—a five-month high (as of publishing).

That’s a far cry from the four-and-a-half year lows the loonie was plumbing in late March, down below 89 cents relative to the U.S. dollar.

Even after this brisk rally, the Street is warning that there may be further appreciation to come in the near future as the “short CAD” trade unwinds. “We would not recommend long CAD as a medium-term trade, given that the Bank of Canada is set on maintaining a dovish policy bias, but the near-term potential for CAD upside seems compelling,” writes Société Générale’s Alvin Tan, who notes that the speculative positioning in the loonie remains short.

In mid-May, Gluskin Sheff chief economist David Rosenberg said there were two words that explained the decline in the Canadian dollar seen over the past year: Stephen Poloz. “The Bank of Canada governor has been rather vocal over the need for the Canadian economy to rebalance via less reliance on consumer spending and housing and more on exports,” he wrote.

Poloz, for his part, has suggested on a couple of occasions that the downward trend could be attributed to increased optimism about economic prospects south of the border—that it was the U.S. half of the pair pushing the Canadian dollar lower. The data, however, do not fit the governor’s narrative.

In fact, there are three words that explain the Canadian dollar’s depreciation in the second half of 2013 and early 2014 and the rebound that followed: Poloz, inflation, and oil.

Consider this annotated chart of the Canadian dollar trade-weighted index (CERI) since the governor took the reins at the Bank of Canada:

Loonie CERI Annotated Chart

The first two words–Poloz and inflation–go hand-in-hand. Though the governor has never explicitly talked down the loonie, there is no doubt that the Bank of Canada’s openness to a rate cut in light of persistently low levels of inflation was the driving force behind the decline in the currency.

Poloz did away with the year-and-a-half old tightening bias. And after repeated warnings from the Bank of Canada that the downside risks to inflation were assuming increasing importance, traders started to seriously consider the possibility that a rate cut might be in the offing, increasing the downward pressure on the Canadian dollar.

Then, abruptly, the primary condition that caused the governor to turn dovish—the disinflationary trend—began to reverse. It’s not shocking that the upside surprise to inflation in February broke the Canadian dollar’s slide. Traders had already begun to figure out that the probability of a rate cut in 2014 was significantly lower than they had thought at the beginning of the year. That print was proof that after years of overestimating inflation, the Bank of Canada had finally erred on the low side.

However, there was also a more fundamental basis for the loonie’s twists and turns: the fluctuations in Canada’s terms of trade. That’s where oil comes into the equation:

CERI v WTI Crude

Historically speaking, there is a loose but reliable connection between the price of crude oil and the value of the loonie. During a speech in Saskatchewan in April, the governor explained this “loose, but dependable” relationship between the Canadian dollar and the terms of trade (read: oil) in typical Polozian style–with an analogy:

For Canada as a whole, where the terms of trade go, the loonie follows. International investors buy good-news stories and, when they buy Canada’s, the value of the Canadian dollar goes up. As a consequence, our terms of trade and the dollar move together, although not necessarily always in sync. It’s like walking a dog on one of those leashes that stretch out and snap back. You might hope he’ll stick by your side, but in reality the dog is always off in all directions. By the end, your respective tracks zigzag all over the place, much like an economist’s chart. But when you leave the park, you’re still together.

In the second half of 2013, all of the loonie’s drivers were pushing the currency in the same direction. Inflation was on the decline, oil was falling, and the Bank of Canada was sounding incrementally more dovish in each policy statement. Now, inflation is rising, oil has surged, and Poloz & Co. have struggled to explain why the downside risks to inflation remain as important as before.

During the first quarter of 2014, firmer than anticipated readings of inflation weren’t having much of an impact on the Canadian dollar. The governor emphasized that temporary factors – high energy prices and exchange rate pass-through – were providing upward pressure on the headline rate, and indicated that the Bank would be keeping a closer eye on core inflation, which continued to linger well below two per cent as of its latest policy statement.

That all changed on Friday, June 20, when May’s inflation data were released and the loonie subsequently spiked. Core inflation appears to be trending back towards its ideal level of 2 two per cent, and traders seem to have finally rebelled against the Bank’s messaging, or at the very least, have closed up their shorts en masse.

Market participants are no longer ignoring or downplaying the rise in inflation.

How long can monetary policy-makers continue to?


What’s up with the soaring loonie?

  1. Setting aside the complexities of economic-babble, I read that: (1) the Can $ is stronger (2) inflation is still below the “optimum”, whatever that means. Where’s the problem? We must be doing something right! Sure, exporters & importers are directly affected – in opposite directions – regardless of $ up or down, so no special pleading. If our balance of payments is a concern, well, this supposedly financially conservative government better get its act together.

    • Funny how our corrupt media didn’t report the prior 11 cent drop. -11 +4 = -7 in my books. Means food, gas, autos, homes, appliances all cost (1.00 / 0.93) 7.% mroe and we are supposed to be happy?

      Wow, media really does BS the people. Usually Macleans does better than this as this is what I expect of CBC brainwashing the economically illiterate.

  2. The loonie is not “soaring”, it is simply off it’s recent bottom just under 90 cents. Not a year ago we were at par. We’ve been bouncing around in a low-90s channel for the past 6 months. No “soaring” to be seen. Oh, and no “plunging” either.

    Honestly, half the articles I read complain of some conspiracy by the government or the BoC to drive the loonie lower. Even the usually level-headed Andrew Coyne got in on this one. The other half of articles moan of the loonie not being low enough to stimulate exports. If neither the sound money advocates nor the devaluators are happy with the loonie’s level, then perhaps it is quite near where it should be, and we can all worry about something else.

    • Raging,

      Sagging exports have more to do with Liberal Policy in Ontario…..than with the value of the Canadian dollar.

      • Lower value money didn’t help Kellogs, Heinz, Caterpillar, 1700 at Bombardier, and more.

        One thing lower value money types ignore is wage pressures and companies material and machinery costs. If all costs go up because of devalued money and workers want raises as gas/housing/food costs more, companies get in a pinch. Take Heinz, lower value money meant tomatoes and sugar, plastics cost more, unions wanted raises but customers refused to pay 11% more for the product, so the plant was closed. Same with bombardier, engines, seats, materials, tires all cost 11% more but the contracts have been struck, so layoffs to save money.

        And people with less value money, more hidden taxes, inflated prices will spend less on other peoples jobs. Several airlines are laying off as fewer people vacation domestically or abroad.

        Reality is, GM and Ontario couldn’t make money at a 62 cent loonie, could make it at par, it is a loser. Reason is we are a tax inflated economy of taxes and debt, raises our wage demands to uncompetitive levels and jobs leave.

    • Richer get richer as they ignore media/political/statism/bank BS. They know the math and how it really works.

      Poor get poorer as they let money, media, banks, govmints manage their thinking and they want people economically stupid and ignorant.

      Canada currency dropped 11 cents with a 4 cent recovery is -11 +4 = MINUS 7%. 1.00 / 0.93 is 7.5% more depreciated money to buy the same food, gas, gold, autos, homes, et al. Prices didn’t go up, wages, incomes, pensions and investment went down 7.5% from devalued money.

      So if you had investment gains of just 12% gains, 4.5% goes to taxes, 7.5% goes to devalued money, you really have made $0 in value.

      But if you moved $100,000 to USA or offshore 1+ years ago, you got 7.5% better returns in CAD terms, 15.5% capital gains and a 4.25% dividends, you cleaned up in the 28% total return before taxes territory. Or that is what I did.

      Or that TSX numbers are new highs, but that ignores 8 years of inflation. In terms of VALUE and purchasing power, the TSX has a long way to go. In fact, the TSX has underperformed the NYSE by over 24% in the last 8 years.

      I have beat the TSX for over 25 years now. Understanding REAL economics and not the govmint/media/academic BS is essential to real wealth building.

      Rich get richer as they look into how it REALLY works.

  3. Well,

    When Angry Tom mulcair stops asking for Peter MacKay’s resignation……..he can try the “Dutch Disease” line again.

    Maybe he’ll have more luck being taken seriously this time. He will still be wrong, but hey, it’s a slow news day.

  4. First off, lets cut the crap. Loonie up in 30 days but down much much more in 8 months is nto a gain.

    My math say 11 cents down, 4 cents up and we say want to party? We must be loooonacy driven as -11 + 4 = -7% in my books.

    But hey, for each $100,000 I moved from CAD investments to USD at par and invested in foreign, I get a (1.00 / 0.93) 7.5% premium on dividends, gains and money…. while everyone gets less value for their pensions and wages.

    Want to know why savvy richer get richer? They don’t listen to media, politicians, banks and wage/govmint economists. We do the math and think VALUE not currency.

    Hey, take the ambulances of crossing new highs from 2006/7, so looonacy I can’t believe it. Me, I am up almost 3 times in value from 2006. I am not celibrating a poor performing TSX that ignored 8 years of inflation. Fact is a 15,200 TSX index buys a lot less goods than it did in 2006.

    In technical terms, media wants us to celibate losing 8 years of cumulative inflation and we should be happy. I am happy as I beat the index, I beat inflation and actually have more VALUE and more purchasing power.

    Your average streat investor better have a lot more money gains since 2006 than the index, or they lost value, and most did.

    Me, I love this economic turmoil from fraud govmints as once you understand the corruption, you can then avoid mistakes like 2008 and bad investments much better. Me, I saw 2008 coming, but statism media and governemtn ignored us, but I had a lot of cash going into the crash.

    I figure this market has more bull, a lot of inflation to catch up too, then perhaps in the fall or winter the correction will come.

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