Since the beginning of this year, out of all the G7 currencies, there has been one that has traded weaker than the U.S. dollar, and that is our sister currency, the Canadian Dollar (CAD), aka the “loonie.”
This has been quite a mystery, with economists scratching their heads trying to understand why this is happening.
There are some fundamental reasons for the weakening:
- The ongoing uncertainty surrounding the NAFTA trade talks.
So far, Canada has dodged a lot of the big bullets that they were anticipating. They were exempted from the steel and aluminum tariffs the administration announced earlier this month and the administration seems to have become more flexible, dropping its earlier insistence that 50 percent of every vehicle assembled in Canada or Mexico must be produced in the United States. There are, however, still some sticking points for the negotiations, particularly around agriculture and softwood lumber.
- The trade talk uncertainties are taking a toll on Canadian business investments and GDP.
Canada reported weak GDP growth of 1.7 percent in the fourth quarter and its stock market is down more than 6 percent year-to-date.
Consequently, the outlook from both the Bank of Canada and the market on future rate hikes in Canada has turned less aggressive compared to what investors anticipated at the beginning of this year, putting more pressure on the loonie.
With all that being said, however, it still doesn't seem justified that the loonie is the weakest major currency. In fact, it's about 5 percent weaker than the euro, 7 percent weaker than the British pound and even more than 8 percent weaker than the Mexican peso this year! And to make things more intriguing, despite its current weakness, many still believe that the loonie will eventually strengthen again by year-end.
My View: The sentiment in the financial markets since the beginning of this year has been cautionary and a long-awaited correction in global equities is feared, resulting in pretty volatile and nervous markets. In the midst of this 'risk-off' sentiment, foreign exchange market participants have not been consistent in determining whether to buy or sell the U.S. dollar, partly because of elevated trade tensions and partly because of U.S. political volatility. Hence, instead of buying the euro, pound or Japanese yen against the U.S. dollar, it seems that investors prefer to buy these currencies against the Canadian dollar as the sister currency to the U.S. dollar, as there are more obvious reasons to sell the loonie. If that is the case, it also means that if indeed the loonie starts strengthening later this year, that might signal that the risk-off sentiment in the financial markets will also have abated.
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