Currencies are notoriously difficult to predict, so why bother?
The Canadian dollar has become a hot topic in recent months. After the loonie surged against the U.S. dollar from May to September, reaching a high above 82 cents (U.S.), many discussions revolved around how long the rally could go on and which Canadian companies were most vulnerable to a strong dollar.
Now, though, the loonie is falling back to earth. It broke below 78 cents this past Thursday, to its lowest level since July, and the discussion has quickly reverted to how low the dollar can fall.
CIBC World Markets believes the Canadian dollar will retreat to 75 cents by early next year, based on the declining odds of another interest-rate hike by the Bank of Canada, along with various White House policies that could drive the greenback up.
Similarly, BMO Nesbitt Burns expects the dollar will trade at an average of 78 cents against the U.S. dollar in 2018, down from an earlier forecast of 82 cents.
Perhaps these forecasts calling for the Canadian dollar to trade below 80 cents will be spot on. After all, the rationale does sound appealing.
But too often, currency forecasts tend to be wrong or they rely too much on the persistence of current trends: Weaker dollars are supposed to get weaker and stronger dollars are supposed to get stronger.
What should investors do if they are not interested in betting on short-term currency moves?
The first thing is to recognize that the Canadian dollar probably won't do what you want it to do.
There are a lot of moving parts to currencies. The Bank of Canada has some influence on the dollar's direction with its interest-rate policies. Indeed, the central bank's two back-to-back rate hikes fuelled the loonie's rise earlier this year.
But there are far more influences. The price of oil is one. This past decade, when the price of crude oil rose above $140 (U.S.) a barrel, the Canadian dollar traded above par with the U.S. dollar, making it a "petro-currency" in the eyes of many observers.
There are also U.S. developments to consider here. How the U.S. economy performs, what the Federal Reserve does with interest rates and what U.S. President Donald Trump says about the North American free-trade agreement or appointing a new Fed chair can all have a massive influence on the direction of the U.S. dollar – and, therefore, the Canadian exchange rate.
Getting all of these things right (especially the part about the mercurial Mr. Trump) isn't easy. Chances are, you'll get something wrong.
The second thing for investors to consider is that being a contrarian can bring sweet rewards. Shopping for U.S. assets when the loonie is strong means that you're cashing out of the Canadian dollar. But it also means that you are getting more bang for your buck elsewhere, which seems like a good move for long-term investors.
Conversely, selling some U.S. assets when the loonie is weak means that you are buying the Canadian dollar on the cheap and locking in some U.S.-dollar profit – also not a bad bet for most investors.
There is no magic formula that I know of for timing these moves with any sort of precision, but moving against prevailing trends is a good place to start.
If forecasters are tripping over themselves with higher targets for the Canadian dollar, perhaps the rally is nearly over. Conversely, lower targets could set the stage for a rally.
The financial market can also provide some clues. When currency investors all seem to be making the same bet on the Canadian dollar, indicated by net speculative positions, any confounding news – a surging oil price, a new hawkish tone from a central banker, a sudden shift in employment figures – can send investors scrambling to change their bets.
If that sounds simple, it's not. But easing into U.S. stocks when the Canadian dollar is high, and away from them when the dollar is low, has always seemed like a good idea.
And today, with the loonie off its highs but still well above recent lows, it's best to just tune out the forecasts and wait for a clearer opportunity.