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Loonie Lunacy?

There was a pundit who once said that he pays attention to even the most dire predictions because eventually they become true. That’s certainly a provocative statement, especially since there’s no shortage of dire predictions given what’s happened to the global markets since the start of the year.

The latest prediction that caught our attention is Macquarie Group’s forecast for the Canadian dollar to fall to US$0.59 by the end of the year, and then remain at depressed levels through 2018.

The loonie currently trades just below US$0.70, its lowest level since 2003. That’s a far cry from when the currency pushed above parity with the U.S. dollar at the height of the global commodities boom.

Notably, if the Canadian dollar were to sink to US$0.59, that would be a few cents below the 2002 bottom, which was the currency’s lowest level over the roughly 45-year period for which we have data.

Macquarie’s bold forecast is also an outlier among its peers. Indeed, the analyst with the next-worst forecast for the loonie sees it bottoming just below US$0.67.

Back in late November, when the Canadian dollar was trading at US$0.75, we wrote, “Since markets have a penchant for drama, we wouldn’t be surprised to see the exchange rate drop to US$0.70 following a [U.S. Federal Reserve} rate hike.”

But it seems that some analysts have an even greater penchant for drama than the market.

The main reason someone might give credence to Macquarie’s forecast, aside from the prevailing atmosphere of doom and gloom, is that this particular analyst earned a top ranking from Bloomberg for his forecasts about the currency last year. In other words, he seems to have won the race to the bottom.

There’s no question that the Canadian dollar will remain under pressure over the next year. And it might not even take a fat-fingered forex trader hitting the wrong button to prove this particular analyst right.

After all, US$0.59 is only about 15% below the current level, and we’ve already seen the currency slide from US$1.06 just a few years ago.

But markets are forward-looking by nature, and a lot of the doom and gloom out there is already priced into the currency. And it does seem to strain credulity that the current economic climate is worse for the currency than at any time since 1971.

We’d probably have to see global deflation rear its head in a meaningful way for that truly to be the case. And Macquarie’s not making that case.

So what’s Macquarie’s rationale for its forecast? The analyst believes that Canada’s economic straits are worse than in the 1990s, especially given the country’s greater dependence on oil. Back then, Canada’s export economy tilted more toward manufacturing than energy.

He says the fact that the manufacturing sector has yet to fully recover after being gutted during the last downturn means that it won’t be able to fill the gap left by crude’s crash.

In the near term, of course, the Bank of Canada’s monetary policy will likely weigh the most on the currency. While futures markets give nearly even odds to another quarter-point rate cut following the central bank’s meeting next week, those odds rise to 64% by March.

At the same time, pressure is mounting on Ottawa’s recently elected Liberal government to front-load more of its promised stimulus spending. That’s because we’re already near the limit of what monetary policy can achieve, even if negative interest rates are now part of the Bank of Canada’s toolkit.

The government vowed to put C$60 billion toward infrastructure spending, but only C$17.4 billion of that has been allocated for the government’s first term. That’s classic politics, but if the lower loonie continues to pinch voters’ pocketbooks, then the government could be compelled to do more sooner rather than later.

And a more robust fiscal policy would help support the economy, while also putting the currency on a steadier footing.


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