OTTAWA, Ont. — The rise in the value of the Canadian dollar against the American greenback has caused considerable trouble for Canadian carriers. Respected Canadian economist Stephen Poloz explains why the pressure may be easing, in this excerpt from his weekly column for Export Development Canada:
It is a fact of life for those of us who follow and forecast currencies: exchange rates move in one direction until something turns them around. And the U.S. dollar may have just hit a turning point.
For some time, now, markets have been transfixed by the view that the U.S. dollar must keep declining to reduce America’s trade deficit. Yet the dollar has been falling for three years, and the trade deficit has only become larger.
Never mind that the world today is far different from the world of 1997-2001, which was riddled with emerging market crises. Never mind that the dollar rose dramatically during 1997-2001, before it began to fall in fact, all it has done is to return about to the value it held the last time the world was in calm waters, which is to say 1995-96.
Perhaps it is the whiff of peace floating around the Middle East, or the successful election in Iraq, which together may be helping oil prices to ease, that has prompted the recent rebound in the U.S. dollar. Perhaps currency markets find Mr. Bush’s austere budget reassuring.
But, as is often the case, it was probably Alan Greenspan (Mr. G.) himself, speaking in London during the G-7 meetings, who created the turning point in currencies. "The U.S. current account deficit cannot widen forever, but fortunately the increased flexibility of the American economy will likely facilitate any adjustment without significant consequences to aggregate economic activity," he said. In other words, global imbalances can ease without there being a U.S. recession.
Mr. G. also said, "The dramatic advances over the past decades in virtually all measures of globalization have resulted in an international economic environment with little relevant historical precedent." In other words, it is much tougher to attach economic significance to international trade balances today, when globalization means that so much international trade is within firms.
Whatever the catalyst, the U.S. dollar has rallied across the board, which suggests that its downtrend may have been broken. It is too early to declare a new trend, but perhaps it means that we can begin to focus on Canada’s fundamentals when forecasting the Canadian dollar.
Three fundamentals stand out. First, the Canadian dollar has become a petrocurrency, and if oil prices continue to ease, so will the loonie. Second, the loonie typically follows cycles in non-energy resources prices, and they have been plateauing for several months. Third, markets have gelled around the view that the U.S. Federal Reserve will continue to raise interest rates, while the Bank of Canada stands pat. The implication is that the Canada-U.S. interest rate differential, currently zero, may soon turn negative against Canada, further weakening the Canadian dollar.
In sum, with the U.S. dollar stabilizing, and Canada’s currency fundamentals either steady or easing, there is reason to expect the loonie to drift lower, probably into the US 75-78 cent range.
The bottom line? Canadian exporting companies should not take too much solace from the recent shift in currency trends, as volatility remains the order of the day. But thanks, Mr. G
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