The loonie’s bumpy ride

Economists disagree on where the Canadian dollar is heading but they are on the same page with how it will get there.

“One of the key messages we have for investors at the moment and for people exposed to FX (foreign exchange) movements is that volatility is back,” said Shaun Osborne, chief foreign exchange strategist with Scotiabank. “Currency movements are likely to stay relatively choppy on a go-forward basis.”

There had been unusually low volatility in currency markets since the U.S. Federal Reserve (Fed) instituted its quantitative easing bond-buying program in 2009 in the wake of the global financial crisis.

The ups and downs that normally characterize currency markets are back since the program ended in October 2014.

That can be seen with the recent rollercoaster ride of the Canadian dollar. It fell from around US78 cents in mid-2015 to 68 cents by January this year and has since recovered to 78 cents.

“It has gone from the worst performing currency among G7 nations to the best performing currency,” said Royce Mendes, senior economist at CIBC.

“The outlook from here on out is similarly bumpy.”

Mendes expects waves of weakness followed by waves of strength.

The weak loonie had been a major factor in shielding Canadian farmers from slumping global commodity prices and keeping exports flowing.

Osborne said the loonie fell last year due to weak oil and commodity prices, the looming risk of additional interest rate cuts from the Bank of Canada and higher interest rates in the U.S.

But in the first quarter of 2016 all of those factors reversed.

“Oil prices have recovered and commodity prices more generally have stabilized,” he said.

Expectations of interest rate cuts in Canada evaporated as the Canadian economy improved more than analysts had anticipated.

Trade data, manufacturing data and retail sales have all been a pleasant surprise.

Meanwhile, the U.S. economy did not perform as well as expected decreasing the likelihood of the Fed implementing a series of interest rate hikes.

Mendes said there may be one or two increases instead of the four that were expected back in January.

Osborne believes the Canadian dollar will gain strength over the next three to six months, primarily due to rising oil prices and a strengthening global economy.

China posted 6.7 percent growth in gross domestic product for the first quarter of 2016 and it appears that the second quarter is off to a better start.

“That’s going to be supportive for commodity prices,” he said.

Canada also had a good first quarter. Scotiabank expects that the growth in GDP will come in well above the Bank of Canada’s 0.8 percent estimate.

“There is every chance the Canadian dollar can probably increase another two or three cents from current levels,” said Osborne.

He believes it will drop back to 78 cents by the end of the year and then gain steam in 2017, averaging in the 83 to 85 cents range due to further gains in commodity prices, an improved global economy and the fiscal stimulus contained in Canada’s recent federal budget.

Mendes has the opposite view. There are signs in trade and manufacturing data that the Canadian economy will slow in the second quarter.

“That should add pressure to the loonie,” he said.

Oil prices are already up $10 per barrel from the January low. He sees no further strength in the short-term.

Mendes also believes the first quarter weakness in the U.S. economy is an anomaly. There has been plenty of job growth in the U.S. and consumer income is rising.

For some reason consumers didn’t increase their spending in the first quarter but he believes they will in the second quarter.

That should lift the U.S. dollar and Mendes believes the Canadian dollar will fall to 73 cents by the third quarter.

By then there should be a better balance in world oil markets supporting oil prices. He also expects a long-term recovery in Canada’s non-energy exports and a boost in manufacturing activity.

That will push the loonie to 75 cents by the end of the year and 78 cents by the first quarter of 2017.

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