Ongoing weakness in the jobs market, the prospect of a jumbo interest rate cut from the Bank of Canada, and the growing policy divergence with the US Federal Reserve are all hammering the Canadian dollar. Currency watchers say the pain could persist.
Following the sharp spike in the unemployment rate in November, many analysts expect the Bank of Canada to trim interest rates by half a percentage point. The increased likelihood of another aggressive cut immediately impacted the loonie, dragging it down to one US dollar equaling nearly C$1.42 as of Dec. 9—the loonie’s lowest level since 2020, down from C$1.40 just before the jobs report was released on Dec. 6.
The Bank of Canada is already far ahead of the Fed in terms of the size and speed of its rate cuts. As expected, the November employment data triggered a swift downdraft in the Canadian dollar, which was already in a downward spiral against its US counterpart.
Bank of Canada Rate Cuts Hit Loonie Hard
The current slide in the loonie is just the latest leg down since it reached its strongest level against the US dollar at C$1.21 in May 2021. At the start of 2024, the loonie traded at C$1.34 to the greenback. Continued economic weakness and successive interest rate cuts by the Bank of Canada exerted downward pressure, bringing the currency to its current value of nearly C$1.42.
National Bank deputy chief economist Matthieu Arseneau says the loonie may continue to slide as policymakers continue to cut interest rates faster than their peers south of the border. “And as long as economic data supports it, the Bank of Canada will continue to cut rates,” he says.
That weakness in the currency is entirely consistent with the relative weakness in the economy, BMO chief economist Doug Porter wrote in a note. “There is a longstanding relationship between the currency and the Canada-US unemployment rate spread,” he says. “When Canada’s jobless rate is relatively much higher, as has been the case in recent years, the currency is on the defensive.”
In November, Canada’s 6.8% unemployment rate put it a full 2.6 percentage points above the US jobless rate. Aside from the pandemic distortions, “that is the widest spread since 2001,” Porter explains. The Canadian dollar faces multiple headwinds even before factoring in the potential damage of threatened tariffs from the US, which could further shrink its value. “The lowly loonie has been left out in the cold, while most global financial markets are rollicking into the finish of a banner year,” he says.
Will the Canadian Dollar Continue to Decline?
Based on precedent, Porter forecasts that the loonie’s weakness could drag on well into the next year. “History suggests that the unemployment rate gap leads the currency by six months or more, suggesting that the Canadian dollar will remain soggy through the first half of next year,” he notes.
IG Wealth spokesperson Philip Petursson voices similar concerns over the divergence in the pace of cuts between the US and Canadian central banks. “The unintended consequence of supporting the Canadian economy with additional rate cuts is a lower loonie,” he says. “Today’s price action is right in line with expectations.” By the look of things, this is far from over. “The loonie will be pushed lower as [the US] Fed easing slows while the Bank of Canada easing picks up,” he says. “The Bank of Canada will have to tolerate a weaker loonie, and potentially higher inflation, if it wants to support the Canadian economy.”
Desjardins strategist Tiago Figueiredo is a rare optimist, seeing a glimmer of hope for the loonie’s rebound: “The US dollar has seen broad appreciation in the run-up and following the US election, and there might be some room for a pullback which should lead to a stronger Canadian dollar [in the] near term.” He says the near-record short positioning among speculators in financial futures also indicates scope for the Canadian dollar to regain some of its lost strength. For now, though, he thinks the rocky ride is set to continue, with the market pricing a staggering 80% chance of a 50-basis-point interest rate cut this Wednesday.
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