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Trump’s stance on trade is hurting the Canadian dollar

The loonie has hit its lowest level in more than eight months

by Vanmala Subramaniam
Mar 16 2018, 6:30pm

As of Friday morning, one Canadian dollar was worth just 76 American cents, a dismal figure indeed, even if one were to compare its value to just a month ago, where it was five cents higher. In fact, since May 2015, the Canadian dollar has never gone above US$0.82, a far cry from the heydays of 2013 and early 2014, when our currency was almost at par with the U.S. dollar.

So what’s really going on here and will we ever return to a point where vacationing in the U.S. will be as affordable as it was five years ago?

Trump and trade wars

U.S. President Donald Trump’s protectionist stance on American industries has ratcheted up to a point where an all out trade war between Canada and Europe on one end of the spectrum, and the U.S. on the other, seems a very likely possibility. Canada is entering its eighth round of NAFTA negotiations in early April, and while Trump has promised that Canada will be exempt from steel and aluminum tariffs that were announced last week, that will only last as long as the former reality TV star gets his way at the NAFTA negotiating table.

All this weighs heavily on the Canadian dollar — it’s getting dragged down by the increased fear that a global trade war will affect the Canadian export industry negatively, says Karl Schamotta, a currency specialist and Director of FX research at Cambridge Global Payments. In the last month alone, the Canadian dollar has dropped by five cents against the greenback — most of that decline came around the time that Trump announced his steel and aluminum tariffs plan.

“Trump’s approach to trade raises uncertainty about Canada’s path forward when it comes to our imports and exports,” Schamotta told VICE Money.

An trade war might also mean that the Canadian government will intervene to ensure the loonie remains weak. A weak loonie is good for Canadian exports — it means that for other countries, Canadian goods are simply cheaper to purchase today than they were back in say, 2013. In order to make sure Canadian exports remain competitive, the Bank of Canada might fiddle with interest rates (not raise them, or perhaps lower them) to keep the Canadian dollar low. Even the expectation that this might happen is what is perhaps keeping the Canadian dollar at just US$0.76.

Interest rates and the Bank of Canada

As a rule, a country’s exchange rate tends to move in tandem with the interest rate. Higher interest rates usually attract foreign capital, because it offers lenders a higher return relative to other countries — that causes the exchange rate to rise. Since July, the Bank of Canada has raised interest rates three times and the loonie has generally responded positively to those interest rate bumps. Recently however, the Bank of Canada has been expressing concern over the level of household indebtedness — for every dollar of dollar of household disposable income, the average Canadian owes $1.70.

“Household debt has been one of the central bank’s top concerns for quite some time, and is figuring prominently in a list of issues the Bank is watching as the economy adjusts to higher rates,” Bank of Canada Governor Stephen Poloz said recently. “The bank estimate the economy may be as much as 50 percent more sensitive to a given rate of interest than it was about a decade ago.”

This only means that the likelihood of the Bank of Canada raising interest rates in the near future is low, as long as Canadian debt levels remain a concern. “That’s placing considerable downward pressure on the loonie,” Schamotta told VICE Money.

“The Canadian economy is driven by consumption. Households are willing to spend. A weaker loonie will cut the purchasing power of the average household,” he added.

What about oil prices?

The biggest reason why the Canadian dollar dropped considerably in 2014 and 2015 was the oil slump that sent crude oil prices tumbling from $105 a barrell to just $50 in the span of a months. But Schamotta points out that because of current oil prices, Canada is simply not a “petro country” any longer. In 2016, the energy sector accounted for just seven percent of nominal GDP, according to data from Natural Resources Canada.

“Historically the Canadian dollar was a petro loonie and so we saw a really strong correlations between oil and our currency movements. Now oil prices have settled into a steady range and we just haven’t seen much volatility so this this has ceased to be a factor that really affects the loonie,” Schamotta said.

How low could it go?

Currency strategists like Schamotta predict that as long as NAFTA negotiations remain tense, Trump’s trade stance protectionist, and interest rates don’t rise, the Canadian dollar will probably hover at the US$0.75 mark for the next little while.

“It might weaken a little more, but I certainly don’t prescribe to the view that we might hit 60 cents or something at that level,” Schamotta said.

“The Canadian economy will remain strong, our government is not indebted the way they are in the U.S. so I think its fair to say that at its fundamental level, the Canadian dollar should remain at about 75 cents.”

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