Why the Loonie Could Swan Dive in 2016

I recently spoke to a Canadian authority in foreign exchange, Rahim Madhavji, who is president of KnightsbridgeFx based in Toronto.
2015 was a busy year for Canada, he noted. But it was not kind to the loonie. Over the year, the Canadian dollar declined 16.45% against the U.S. dollar. In the wake of January’s surprise rate cut by the Bank of Canada, the loonie suffered amidst an environment of stagnant growth.
Madhavji believes that across the nation Canadians have been feeling the impact of the weak Canadian dollar. Importers, snowbirds, and consumers alike are asking the same question: Will 2016 be a different story for the loonie?
Along with other nations for which commodities are an important component of the domestic economy, the Canadian dollar is identified as “commodity currency.” These currencies tend to perform well in tandem with commodities. Commodities, namely oil, did not perform well in 2015, as WTI fell 30.18% in 2015. Early in 2016, oil prices are below $30/barrel, and approaching $25/barrel with alacrity.
The main reason for 2015’s oil price shock was side factors, as many OPEC nations refused to curtail production. Geopolitical tensions between Iran and Saudi Arabia make it unlikely that supply will be limited any time soon.
With major economic concerns arising for both the European and Chinese economies throughout 2015, any material demand increases in the short term are unlikely. Therefore, oil prices don’t look poised to improve in the short term, which will weigh on the Canadian dollar throughout 2016.
The Canadian economy performed quite poorly in 2015, and remains a focal point moving forwards. However, the economy began to improve marginally towards the tail end of Q3.
Moving forward, the Bank of Canada is hoping that non-energy exports will help to offset the effects of low oil prices on the Canadian economy. Despite holding rates at January’s meeting, the Bank of Canada expects GDP growth of 1.5% for 2016. Over the course of 2016, we will see the effect of the low Canadian dollar begin to trickle down into an increase in exports.
Without a sharp uptick in oil prices, it’s likely we will see the Canadian resource sector continue to weigh on the Canadian economy at large. Specifically, Western Canada is unlikely to see substantial economic improvement in the short term. Poor Canadian economic performance will plague the Canadian dollar throughout 2016.
The Bank of Canada was active in 2015, making several rate cuts in an attempt to stimulate the economy. Governor Poloz has shown a willingness to act preemptively, as well as a willingness to base monetary policy decisions on oil prices.
Meanwhile, the U.S. economy showed great signs of improvement throughout 2015. The U.S. labour force is quickly approaching full employment, currently pegged at 5.1%. Promising underlying fundamentals have contributed to broad-based U.S. dollar strength. Inflation has lagged slightly behind expectations, with the strong U.S. dollar likely contributing to this.
Further rate cuts in 2016 by the Bank of Canada remain a possibility. The Bank of Canada will assess the stimulus budget package that will be implemented by Finance Minister Morneau and the Liberal party in 2016. We can expect to see fiscal policy affect monetary policy decisions more heavily.
The Federal Reserve already moved to raise rates during December of 2015, in contrast to the 2015 rate cuts in Canada. The path to normalization for the U.S. will be a continuing saga throughout 2016, as rates are expected to rise slowly. The divergent monetary policy between the two nations has helped support the U.S. dollar. 2Y treasury spreads have increased against their Canadian counterparts, representing the divergence in monetary policy.
Upon closer analysis, Madhavji believes that the key drivers of the Canadian dollar imply further downward pressure for the Canadian dollar. The loonie is clearly lacking a catalyst early in 2016, and it appears the Canadian dollar will not fare much better in 2016 than it did in 2015.
In 2003, we saw USD/CAD reach levels of over 1.60. While it would take a further plunge in oil prices and a recession to reach similar levels, a further drop in the loonie remains in the cards if the Canadian economic climate does not improve.