The New Year has ushered in a new reality for the Canadian dollar, as the loonie has consistently traded above parity compared to the U.S. dollar so far this year.
While it is still early days, I continue to believe the Canadian dollar will move from strength to strength this year, ultimately rising to $1.15 against its U.S. counterpart.
The Canadian dollar’s vitality is in part a reflection of weakness in the U.S. dollar and the euro, as investors continue to question the implications for growth prospects in these two regions, as they struggle to come to grips with massive government debt loads.
The Canadian dollar is also benefitting from capital flows, as strong emerging market economies such as Brazil, Chile and Peru all have taken steps recently to weaken their currencies. Canada remains a bastion of stability in an uncertain world. While our fiscal situation is far from perfect, it is entirely manageable. Canada will readily return to budgetary surpluses over a five year time frame, while the Bank of Canada remains committed to price stability and the normalization of interest rates, the only G7 country to do so. This set of dynamics will remain attractive to foreign investors and capital inflows.
When Canadians think of a strong Canadian dollar, perhaps their thoughts turn to the allure of cross-border shopping, or the headwinds to our exporters or the benefit to importers.
But one other aspect to bear in mind is the impact of a strong loonie on our investment portfolios. If you buy a foreign investment and don’t hedge your currency exposure, you are making an implicit “bet” that the Canadian dollar will remain unchanged in value against its foreign counterpart or that it will depreciate and add to your investment returns.
If you agree with me that the odds favour a further strengthening of the loonie against its G7 counterparts this year, then you should take a look at your investment portfolio and consider a hedging strategy that takes currency totally or partially out of the return equation.
Currencies are extremely difficult to predict; I know as I have been humbled many times in a 30-year career of forecasting. So, you may consider the path of least regret, or a 50 per cent hedge ratio. This will provide some insurance as the stars align for a strong Canadian dollar this year.
Patti Croft recently retired as chief economist, RBC Global Asset Management, with 30 years of experience on Bay Street working as an economist and global asset allocation strategist.
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