Canadian Dollar's Future in a Risk-Prone World: A Gloomy Outlook

03 Nov, 2023

Canadian Dollar's Future in a Risk-Prone World: A Gloomy Outlook

Contrary to expectations of a stronger Canadian dollar in 2023, the loonie has instead experienced a significant decline, reaching a six-month low of 72.43 US cents. The driving forces behind this unexpected trend have shifted. Previously, a hawkish Bank of Canada, with interest rate hikes, supported the loonie. However, with the slowing economy reducing the likelihood of further rate hikes, new factors have come into play.

Geopolitical instability is a prominent factor affecting the Canadian dollar's performance. The outbreak of conflict in the Middle East has diminished global risk appetite, impacting currencies such as the Canadian dollar.

Analysts from Monex Canada suggest that if the geopolitical situation worsens, the loonie could drop as low as 71.4 US cents.

Another significant influence is the global bond market's turmoil. The increase in long-term Treasury yields has led to a resurgence of the U.S. dollar, affecting most other currencies.

Additionally, the divergence between the Canadian and American economies is surprising. Historically, there hasn't been a substantial difference in GDP growth rates between the two countries due to Canada's economic reliance on its southern neighbor. However, in the third quarter, the U.S. GDP exhibited a robust 4.9% annual rate of growth, while Canada, according to early estimates, experienced a slight economic contraction.

Monex Canada FX market analysts Jay Zhao-Murray and Simon Harvey highlight this contrast, emphasizing that as Canada grapples with stagnation and the potential of a looming recession, the U.S. economy appears poised to strengthen further from an already robust growth pace.

Douglas Porter, Chief Economist at BMO, points out that Canada's population growth has significantly outpaced that of the United States, making the divergence in per capita GDP growth even more remarkable. While U.S. GDP per capita has grown by over 2%, Canada's per capita GDP has declined by more than 2%.

The explanation for this disparity lies in the financial strains on indebted Canadian households, who are cutting back on spending due to higher borrowing costs, while Americans continue to consume. Canada's economy is also more sensitive to interest rates, with the housing sector representing a larger portion of its GDP.

Furthermore, the United States' fiscal policy is contributing to its economic strength. The U.S. budget deficit for the year has expanded to $1.7 trillion, exceeding 6% of GDP, while Ottawa's deficit came in lower than anticipated at $35.3 billion, equivalent to 1.3% of GDP.