The farm lender maintained its prediction that GDP growth would slow to around one per cent.

The effective blockade of the Strait of Hormuz, which has restricted the flow of oil and gas from the region, has pushed commodity prices to multi-year highs, FCC economist Krishen Rangasamy wrote in a March 18 report.

Pros and cons

The jump in prices could spell opportunity for Canada, Rangasamy said.

WHY IT MATTERS: Higher fuel and fertilizer prices for farmers today could be followed by higher borrowing costs in the future if core inflation persists.

“Given its high historical correlation with commodity prices, nominal GDP (which matters for government revenues) is likely to also perk up.”

If commodity prices stay high, the federal government and governments in resource-rich provinces such as Alberta or Newfoundland and Labrador could see higher revenues. That doesn’t mean governments will spend more, Rangasamy said, but there’s potential for a spending-related GDP boost.

However, fertilizer prices are among those surging due to the conflict which is weighing on the ag sector. Higher prices for fuel can also push up inflation and erode consumers’ buying power.

Trade war damages

Last year, Canada’s economy saw the worst performance since the 2020 pandemic recession — growing just 1.7 per cent, Rangasamy wrote. Export volumes fell on an annual basis for the first time in five years.

Government and consumption spending offset weaknesses in housing and business investment. However, based on a slumping household savings rate, consumers also dipped into savings to maintain lifestyles. This means Canadians have little cushion to absorb future shocks.

“With no end in sight to America’s trade war … look for trade and business investment to act as a drag on Canada’s economy again in 2026,” Rangasamy said.

Government and consumption spending may not provide as much of an offset this time. Rangasamy noted the government has telegraphed caution related to public spending. While ambitious public projects are in the works, that spending isn’t expected this year.

Interest rates and the loonie

If commodity prices stay high long enough, businesses may be forced to raise prices which could lead workers to demand higher wages.

“That could potentially trigger a wage-price spiral,” said Rangasamy.

The Bank of Canada could pre-emptively raise interest rates to prevent core inflation from taking off. However, he predicted the bank would stay in “pause mode” for several months.

FCC predicted the Canadian dollar would trade in the 72- to 74-U.S. cent range for most of the year, but acknowledged currency volatility could temporarily take it outside that range.

On Oct. 1, the loonie was valued at 74.1 cents relative to the U.S. dollar. It then sharply declined, dropping 6.8 per cent in only three months.

A foreign exchange expert in Toronto said the loonie was “vulnerable” to this decline because of the weakness of the Canadian economy.

“The overall level of activity in the economy has slowed quite dramatically. That put is in a vulnerable position,” said Karl Schamotta, chief market strategist with Corpay, which helps companies move money internationally and manage the risk.

The weakness had been growing under the surface, and a catalyst was needed to trigger a sell off. It turned out to be the surprising strength of the U.S. economy, which outperformed expectations in 2024 and prompted the U.S. Federal Reserve to maintain interest rates at a higher level.

Meanwhile, the Bank of Canada continued cuts to its key interest rate in the second half of 2024.

“The gap between Canadian and U.S. interest rates has widened out to the highest level since the ’80s,” Schamotta said, which put pressure on the value of the loonie.

That pressure was significant as traders sold the Canadian dollar and put their money elsewhere.

“December closed at the lowest price (for the loonie vs. the U.S. dollar) in 21 years. That’s pretty significant,” said Trent Klarenbach, a grain market analyst and adviser who runs Klarenbach Research in Saskatoon.

That’s a snapshot of what happened in 2024, but consumers and farmers are more interested in the loonie’s trajectory in 2025.

Financial institutions have projected that the U.S. dollar will stay strong in the first half of 2025, but the loonie could rebound in the last two quarters of the year. That logic is partially based on the idea that interest rate cuts will stimulate the Canadian economy, which will support the loonie.

Like most market watchers, Klarenbach doesn’t see a scenario where the Canadian dollar hits 75 or 77 cents. The only trigger for that would be a spike in oil prices, which seems unlikely at this time.

“What’s going to happen in the second quarter (of 2025) is anyone’s guess, but I do think we can get a rally from the 70 cent levels and back to 72.”

Schamotta expects the U.S. dollar will remain strong in the first months of 2025, but there’s a possible scenario where the American economy slows down and the Federal Reserve responds with a cut to interest rates.

As well, a change in government in Canada should be supportive of the loonie.

“Markets at this point are convinced that (federal Conservative leader Pierre) Poilievre will emerge victorious…. What that (potentially) will do to the economy is already priced into the currency,” Schamotta said.

There is also the looming question of tariffs.

Traders don’t expect that U.S. president-elect Donald Trump will impose a blanket 25 per cent tariff on all goods from Canada, Schamotta said.

However, the risk to Canada’s economy is so great that “traders are in sell-first-and-ask-questions-later mode.”

A lot depends on the relationship between Trump and Poilievre. If that relationship goes well, the loonie could rebound.

“The assumption that markets are making is that Poilievre and Trump will get along better than Trump and Trudeau,” Schamotta said.

“That seems like a fair assumption … but it’s not a certainty.”

The dollar index is a trade-weighted basket of currencies and gives an indication of the strength of the U.S. dollar relative to trading counterparts.

Given the proposed tariff policy of the new U.S. administration, it makes sense that the trade would sell trading partner currencies and buy the greenback.

One would think the Canadian dollar has seen the largest impact of the major trading partners, but the loonie has suffered less than the euro, which has dropped by nearly three per cent since the election.

The Canadian dollar has lost close to 1.4 per cent since November, with the nearby contract trading below the 71.5 U.S. cent level. The loonie is trading at its lowest since May 2020.

How low can the loonie go? It is likely to test the 70 U.S. cent level in coming months and may even test the 68 U.S. cent level, which corresponds to the 2020 and 2016 lows. Given divergence between the U.S. and Canadian economies, there is no reason the loonie can’t trade below the 70-cent level for a significant period.

Canadian farmers should be prepared for currency turbulence in the next few years, and it is hard to foresee events that would cause the loonie to rally. On the positive side, farm gate returns for some should increase.

This gain will be at least partially offset by input costs that are mostly U.S.-dollar related. The next market moving information for the loonie will likely occur when the Bank of Canada announces its next interest rate change Dec. 11. The market expects another interest rate reduction of at least 25 basis points.

Complicating the price picture for Canadian farmers is that the dollar is only one factor in price determination. Commodities are generally adjusting to the strong U.S. dollar by dropping futures values to offset the strong dollar.

There is also a broad selloff in commodities due to a bearish attitude for the sector by funds in general.

A slowing global economy, especially in China, is the main driver of this trade. Crude oil is the chief commodity in funds’ crosshairs, but there has also been pressure across the agricultural sector. Of chief concern are soybeans, which are vulnerable to a U.S. trade war with China.

Other agricultural commodities have also been caught up in negative sentiment for slowing global economic growth. Canola, wheat, corn and soybeans have seen a significant sell off in prices since the U.S. election.

The bad news for farmers is that any currency gains may be offset by declining prices. Sometimes you can’t win for losing.

One thought circulating among economists and analysts is that because of the surprisingly strong economy in the United States, its central bank, the Federal Reserve, could remain wary of inflation and be reluctant to lower interest rates.

Economies in other countries, including Canada, are not quite so robust, meaning inflation pressure could be lower. That could result in a desire to start lowering interest rates sooner.

But if that happens, international money will flow to the higher rate in the U.S., raising the value of the U.S. buck relative to other currencies such as the loonie.

The Canadian dollar’s value versus the greenback is already at a relatively weak level.

Over the past 12 months, the loonie has ranged between US72 to 76 cents.

In 2021 and much of 2022 the Canadian dollar was in a higher range, from 77 to 83 cents, but in September 2022 the worries about inflation around the world could no longer be ignored.

The expectation was that the Federal Reserve, known simply as the Fed, would have to seriously hike interest rates to reduce inflation.

The U.S. economy was hot and expectations were that the Fed would need to be aggressive to cool growth, allow supply and demand to balance, and kill inflation.

The expectation was that the Canadian economy was not as robust and the Bank of Canada would not be able to be as aggressive in raising rates. If it did there would be a greater danger of pushing the economy into recession.

And as already noted, if rates were higher in the U.S., that would support the greenback.

Also, higher interest rates and a cooling economy would reduce demand for Canada’s commodity resources, putting more downward pressure on the loonie.

Another factor at play is the trend that whenever there is global economic uncertainly, money flows toward the safety of the U.S. dollar.

So in the fall of 2022 the loonie fell about five cents, down to 72 cents, and then stabilized in the 72 to 76 cents range we’ve seen for the past 16 months.

The Bank of Canada was almost as aggressive as the Fed, with its interest rate peaking in July 2023 at five percent and holding there. The Fed peaked in July slightly higher at 5.25 to 5.5 percent.

The Canadian dollar was edging toward 76 cents last spring but that higher U.S. rate in July caused the loonie to gradually weaken back down near 72 cents, even as crude oil prices rose to about $90 a barrel in September, a factor that often lifts the Canadian dollar.

However, even as the Fed was using interest rates to pump the brakes, the U.S. economy out-performed expectations.

In the fourth quarter of 2023 the U.S. economy grew 3.3 percent on an annualized basis, according to the government’s preliminary estimate.

Inflation had been beat down to 3.1 percent in November, but edged up to 3.4 percent in December, a major achievement, but still higher than the two percent target.

Canada’s economy, although weaker than the U.S., is nevertheless doing better than expected.

The preliminary assessment put the economy up 1.2 percent in the fourth quarter on an annualized basis.

The fact that both economies continue to grow means that inflation pressure is still a factor and so banks might be cautious about lowering rates too soon.

This is particularly so in the U.S., where the January jobs report issued last week showed hiring twice as high as expected and wages increasing. A tight job market and rising wages puts upward pressure on inflation.

Canada’s January jobs report comes out this week.

If the American economy continues to grow at a spritely pace, with the Canadian economy tagging along, the loonie’s value is likely to continue to range around the mid-70s cents.

But if Canadian growth stalls out and inflation here cools faster than in the U.S., then interest rate cuts could come sooner north of the border and the loonie could drift lower still.

What could change this?

A surprise increase in demand for oil and other commodities could help support Canada’s economy and currency, but that does not seem like a possibility.

Most energy analysts see crude prices mostly steady around the $80 per barrel mark. The World Bank thinks worldwide gross domestic product growth will be a little slower in 2024 than it was in 2023. The International Monetary Fund forecasts growth steady at the modest pace of 2023.