- After a relatively calm year for the Canadian dollar, the loonie now sits within a penny of where it started 2023.
- Coordinated monetary policy between the Bank of Canada and the Federal Reserve has meant there hasn’t been a big difference in the interest rates available to investors on either side of the border.
- That could be set to change in 2024, as the Canadian economy looks more susceptible to weakness, and therefore interest rate cuts.
- Should the Bank of Canada cut before the Federal Reserve, we would expect the USD to gain versus the CAD, a benefit to portfolios with USD exposure.
A subdued year for the Canadian dollar…
In a year that has seen significant volatility in both stock and bond markets, the foreign exchange markets have been curiously calm. So far this year, the peak to trough range for the Canadian dollar/U.S. dollar exchange rate has been 6.2% compared to the long term average of 10.4%. In the past decade we have seen years with annual ranges as high as 20% in 2015, and 15% in 2020. Zooming out the lens a bit, the Canadian dollar appears to be in the middle of a 1.20-1.45 range that has been in place since 2015, with no clear direction in 2023.
… but the stage is set for changes in 2024
One of the largest influences on foreign exchange rate is what is referred to as “interest rate differentials”. While that may sound overly technical, it is just the difference between interest rates in one country and another. Foreign exchange investors tend to gravitate to currencies that pay them more interest, so when one country is offering higher interest rates than another, its currency tends to rise.
One way we can look at future expectations for interest rates is in two year bond yields. As seen below, Canada’s 2-year bond yield was about equal to the U.S. back in the summer, but is now nearly 0.5% lower. This suggests that markets think the Bank of Canada will have to cut interest rates ahead of (or more aggressively than) the Federal Reserve, a sentiment we agree with. Canada’s economy is much more susceptible to higher interest rates and with cracks already forming in real estate, we think pressure will start to build on the Bank of Canada ahead of the Federal Reserve.
RBC’s forecasts suggest a stronger USD over the next six months
With the USD/CAD exchange rate currently sitting around 1.35, RBC’s forecasts suggest some near-term weakening of the Canadian dollar, with the U.S. dollar forecasted to end this year at 1.38 and head up to 1.39 by mid-2024. They see the USD retreating in the second half of the year down to 1.31 at the end of 2024, but these forecasts are based on an expectation that Canadian GDP growth outdoes the U.S. in the second half of 2024. Should the Canadian economy remain held back by increased pressure on the consumer, we would expect U.S. growth to outperform, and with it, the U.S. dollar. While a weaker Canadian dollar doesn’t make trips down to warmer climates less expensive, a stronger U.S. dollar is positive for portfolio performance, and it continues to be one of the few things we can invest in that tends to go up when everything else is going down.
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