The loonie topped US$0.80 today, as a Bank of Canada rate hike is expected later this week.
But the Canadian dollar’s longer-term outlook isn’t so rosy.
Investors going long on the Canadian dollar because of the interest rate story perhaps shouldn’t be, says CIBC chief economist Avery Shenfeld in a weekly economics report.
“Canada’s stubborn trade and current account deficit with the rest of the world means that, month after month, we need fresh capital inflows to prevent the loonie from weakening,” he says.
Instead, net inflows have been dominated by financial inflows to bonds, as opposed to foreign direct investment, which would help build new export capacity.
“Given how fickle these fixed income flows can be, a pause in Canadian rate hikes could send the currency sharply weaker again if the Fed is hiking at that point,” he says.
NAFTA uncertainty also looms.
“The threat to [the loonie] from NAFTA negotiations won’t go away and would justify a lengthy pause in interest rates,” say CIBC senior economists Andrew Grantham and Royce Mendes, in another section of the same report.
Business goes stateside?
With risks of a trade war, and with the U.S. allure of immediate expensing for tax purposes and lighter regulations, multinationals could opt to grow operations stateside, suggests Shenfeld, adding that many companies are running full tilt.
As a result, the loonie would be subject to two negative consequences.
First, capital spending—and eventually exports—would contribute less to economic growth than the Bank of Canada envisages, a reason to go slower on further rate hikes, he says.
Second, Canada’s net trade in goods and services (trade balance) would take a hit.
“Both will have the invisible hand of markets finding a weaker equilibrium for the loonie,” says Shenfeld.
Grantham and Mendes add: “Taking protection against volatility [from NAFTA] over the next three months still looks cheap, and the C$ looks set to fall back toward the mid-70-cent range.”
Read the full CIBC report.