Rising real U.S. Treasury rates and an improving economic outlook have seen the U.S. dollar make big moves higher against most major currencies, not just the loonie. Comparing the decline of the Canadian dollar relative to the euro, yen, Australian dollar, South Korean won and Brazilian real also offers significant clues on the global economic outlook.
The chart below shows the progress of the greenback against sample currencies from the major economies around the world. The extreme weakness in the resource-backed Aussie dollar and Brazilian real highlight the declining faith in Chinese growth.
U.S. dollar vs major currencies: Indexed to 100 in January 2013
SOURCE: Scott Barlow/Bloomberg
The loonie's less destructive (for now) trajectory illustrates the domestic economy's diversification and our ability to pivot from an orientation towards emerging markets growth to benefit from developed world economic expansion.
Australia and Brazil are the world's largest exporters of iron ore, and virtually all of it is sent to feed China's massive infrastructure and real estate boom. Their currencies, which benefitted tremendously from resource wealth, are now seeing the other side of the double-edged sword, falling hard as China's growth outlook dims.
The U.S. dollar/yen cross is a story of its own. Japanese Prime Minister Shinzo Abe is purposefully devaluing the currency as part of a strategy to spur wage inflation.
Many investors are unaware of the importance of the South Korean won as an indicator of global growth. The yen is being manipulated by government policy and the Chinese yuan is loosely pegged to the U.S. dollar, so the won is the most accurate gauge of Asia's regional economic activity.
The won has been one of the few currencies to show stability against the greenback in the past year. This has raised serious concerns for the country's policy makers. As an exporting country competing with Japan for global market share, the stronger won is making exports uncompetitive. Nonetheless, a stronger South Korean currency is a good sign for global growth.
The euro has also climbed against the greenback over the past year. I'm speculating, but I think this reflects that the European Union, while still mired in economic doldrums and political infighting, is expected to improve – albeit from a very low base.
The loonie's been weak, but nothing like the yen or the Aussie dollar. Unlike Australia, the Canadian balance of trade is not entirely dependent on emerging market growth. The ongoing global switch to developed world economic leadership implies the Canadian economy will transition to exporting manufactured goods to the U.S., as resource demand in China fades.
For investors, the key thing to keep in mind in 2014 is that the S&P/TSX Composite is not a good reflection of Canada's diversified economy. At more than 35 per cent materials, the benchmark will likely be weaker if growth continues to slow in developing economies.
However, while the equity market might be weak, the economy can adapt to the new environment. It just won't be visible immediately. Sectors like forestry and auto parts that form tiny fractions of the TSX, will benefit tremendously from U.S. economic growth and add to GDP expansion for Canada. They're just too small, in terms of market cap, to affect the equity benchmark very much.