The Canadian dollar was changing hands for as little as 75.15 US cents at one point on Friday morning. This is the lowest level for the currency since October 2020.
The loonie was down about half a cent from Thursday’s close, in just the latest day of declines in a segment for the Canadian currency. The loonie fell more than a cent on Tuesday after data from the US showed the country’s core inflation was still heading in the wrong direction: up.
It’s not often that one country’s currency falls because of economic data coming from another, but that’s not happening right now because of how big of a problem inflation is.
Stubbornly high inflation in the US increases the chances that the country’s central bank will need to raise interest rates even more aggressively than it has been. The Federal Reserve is set to do just that next week, raising its key interest rate by at least 75 basis points to 3.25%, if not more.
Investment pricing linked to the Fed rate suggests that investors believe the US bank rate will eventually reach 4 or even five percent.
“Rates will peak higher than expected a few months ago and stay there longer than originally expected,” said Audrey Childe-Freeman, currency analyst at Bloomberg Intelligence. “At some point the market will focus on the next Fed cycle [of rate cuts] but that is far away.’
If the Fed rate goes to 4.5 next year, as investors expect, that is much higher than the Bank of Canada will likely be able to go, thus widening the gap in the two countries’ currencies.
How interest rate hikes affect a currency
All things being equal, interest rate increases increase the value of a country’s currency because it makes it more useful for foreign investors to park their money there: they will get a higher return for doing so. This rule of thumb is even more applicable than usual right now because the US dollar is seen as the safest place to keep your money in times of uncertainty. “There’s been an absolute flood of money into the US dollar because it’s the ultimate safe haven and because the US economy is so much stronger than anywhere else,” says Adam Button, chief currency analyst at ForexLive. The loonie looks like it’s taking a swan dive because pretty much anything that isn’t a US dollar has been swamped right now, he says. Compared to other currencies such as the euro, the British pound and the Japanese yen, the Canadian dollar has gained ground this year. But it falls short of the yardstick most Canadians measure it by: the US dollar. Another reason for the loonie’s relative weakness is the softness in commodity prices such as oil and gold as the outlook for the global economy worsens. “Commodities are weak, mainly because the market is (finally) coming around to the fact that the outlook for global demand looks bleak,” says Bipan Rai, currency analyst at CIBC. “That matters for a key proxy like the Canadian dollar.” The price of a barrel of oil has lost about $30 since June, which under normal circumstances would be more than enough on its own to drag the loonie down. But that selling pressure is exacerbated by what investors believe central banks are going to do. While Canada’s central bank is also raising interest rates aggressively, pain in the country’s housing market and consumer spending will likely force the central bank to stop hiking soon. “Up until the last week, the market was saying both would stop at around 4%,” Button said. “Now the market is saying the Fed may go higher, but the Bank of Canada may not.” If that happens, that’s a recipe for even more money to flow into the US dollar, so Button wouldn’t be surprised to see the loonie fall below 73 cents by the end of the year. “Canadians may not fully appreciate how bad things are,” he said.
