On the other hand, the Loonie is being punished by the Eurozone debt crisis and the consequent flight to safe haven currencies: “The Canadian dollar is following the risk aversion tones of the market.” While the Loonie might have otherwise been “been closer to parity” then, it’s understandable that the so-called “panic trade” is holding it down.
In light of the Eurozone debt crisis, however, one might have predicted that commodity currencies would rally, since they are perceived as being backed by something more tangible than government fiat. In fact, some analysts believe that the comparatively modest decline in the Loonie implies that this is indeed the case: “It was fascinating to see the Canadian dollar only correct down to 92 cents during this most recent round of global financial turbulence and flight-to-safety. That is a far cry from the correction down to 78 cents following the Lehman aftershock, not to mention the move down to 62 cents after the tech wreck a decade ago.”
The same analyst pointed out that the notion of the Canadian Dollar as a safe-haven currency is further justified by Canada’s strong fiscal condition. It is trimming its spending, cutting taxes, and may even reduce its national debt. Meanwhile, it’s financial system remains robust, as evidenced by the fact that none of its banks have required government bailouts. Thus, Canadian sovereign debt has continued to appreciate in spite of the crisis across the Atlantic. In short, “The federal government actually deserves the triple-A credit rating that it receives on its debt.”
Going forward then, the near-term performance of the Loonie will depend both on the EU sovereign debt crisis and commodities prices, which in turn are high sensitive to (perceptions of) the global economy. In this latter aspect, there is tremendous uncertainty. The Canadian economy did grow at 6% last quarter. However, “The fear is that weaker U.S. data is posing a risk to the Canadian economy. And the G-20 is really focused on fiscal restraint as opposed to supporting growth. That probably isn’t good for the growth currencies.”
Furthermore, there are implications for the Bank of Canada, which has already embarked on a tightening of monetary policy. It raised its benchmark interest rate – becoming the first industrialized economy Central Bank to do so – to .5% in June, and there is a 45% chance that it will do so again in July. The futures markets are currently pricing in a benchmark rate of 1.25% by year end. Ultimately, “The extent and timing of any additional withdrawal of monetary stimulus would depend on how the outlook for economic activity and inflation evolves.”
For now, interest rate hikes are largely beside the point as investors remain firmly focused on the EU fiscal crisis: “People are taking risk off heading into the summer, to reassess,” summarized one trader. A resolution of the crisis, would surely send the Loonie back towards parity. In the interim, Canada’s strong fundamentals will ensure that it won’t fall much further, poised to strike when the time comes.
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