Canada and the United States are on diverging economic paths, fuelling a rise in the value of the loonie that some expect will gather steam in the coming months.
Boosted by a recent spike in oil prices, better-than-expected domestic wholesale trade numbers and increasing speculation that the U.S. Federal Reserve will cut interest rates next month, the Canadian dollar strengthened to close at 75.91 cents against its U.S. counterpart Tuesday, nearing the three-month intraday high it touched last week.
“We’ve seen Canadian data hold up really well. … We’ve had some stellar employment data in the last month or two and inflation numbers have been creeping higher,” said Bank of Nova Scotia chief foreign-exchange strategist Shaun Osborne. “The U.S. dollar is likely to weaken over the next 12 to 18 months heading into 2020.”
The loonie is up 3.8 per cent against the greenback this year, a trend that threatens to hit margins at Canadian companies – particularly those in the forestry, financial services and manufacturing sectors – if it continues through the summer.
A interest-rate cut next month in the United States would likely drive the loonie higher. The U.S. central bank suggested last week that it could implement rate cuts as early as July; the Federal Reserve last cut rates in 2008. U.S. President Donald Trump has been publicly critical of Fed chair Jerome Powell for not making the move sooner.
Interest-rate futures markets are predicting a 100-per-cent probability of a rate cut when the Fed next meets on July 31. The chance of a Bank of Canada rate cut by the end of the year sits at 50 per cent, according to data compiled by Bloomberg.
On Tuesday afternoon, Mr. Powell avoided committing to a rate cut, but suggested that increasing uncertainty over global trade tensions and concerns of weakening inflation continue to weigh on the economy.
“The question my colleagues and I are grappling with is whether these uncertainties will continue to weigh on the outlook and thus call for additional policy accommodation,” Mr. Powell said.
A weaker U.S. dollar could put pressure on companies that bring in more of their earnings from the U.S., such as industrials, financials, and those in paper and forest products, warns a recent report by RBC Capital Markets.
Canada’s forestry industry, which is already struggling with a slump in lumber prices, derives most of its earnings from the U.S. Half of the companies in the report get more than 50 per cent of their revenue from south of the border. Lumber producer Interfor Corp. generates 72.1 per cent of its revenue from the U.S. and paper and pulp maker Domtar Corp. comes in a close second at 67.3 per cent.
Costs to transport materials such as lumber could spike in the wake of a weak dollar. Major industrial companies such as Canadian National Railway and Canadian Pacific Railway derive more than a quarter of revenue from the U.S. A stronger loonie also increases the cost of shipping products with a Canadian company.
“A strong CAD makes the revenue derived in the US less valuable, and makes shipping with a Canadian rail more expensive,” the report said.
Banks and insurance providers are also particularly vulnerable, bringing in an average of 17 per cent and 26.6 per cent of earnings respectively from the U.S.
BMO Financial Group, TD Bank Group, Manulife Financial Corp. and Sun Life Financial Inc. all generate a third or more of their earnings from the U.S.
The loonie’s rise on Tuesday was driven in part by strong wholesale trade in April. Wholesale trade that month rose 1.7 per cent on improved sales in the motor vehicle and motor-vehicle parts and accessories subsector, exceeding economist expectations of a 0.2 per cent increase.
While the loonie could continue its strong streak on strong employment numbers and wage increases, it could weaken again as early as the end of the year, according to the Canadian Imperial Bank of Commerce. Slowing global growth and a more expensive Canadian dollar could inhibit business investments and exports as Canada waits to figure out the latest trade agreement with its largest export market.
“Global protectionist risks are at the forefront of the Bank of Canada’s mind and it could veer towards a more dovish stance if things continue to deteriorate,” said Bipan Rai, CIBC’s North America head of foreign exchange strategy. “We’re also looking at the [the United States-Mexico-Canada Agreement on North American trade] and whether or not it’s going to be ratified both in Canada and the United States, and I would argue that the United States is probably the biggest threat as to whether or not it’s going to be ratified.”