The Canadian dollar has fallen to its lowest level in almost two years – here’s why

The Canadian dollar fell to its lowest level in two years. (DirkKafka/stock.adobe.com – image credit)

The Canadian dollar fell to its lowest level in nearly two years on Friday, as investors around the world surveyed expectations of a deteriorating economy and headed for the safety of the US dollar.

The Canadian dollar traded for 75.15 US cents at one point on Friday morning. This is the lowest level for the currency since October 2020.

The Canadian dollar was down about half a cent from Thursday’s close, its last down day in part for the Canadian currency. The Canadian dollar fell more than a cent on Tuesday when data from the United States showed the country Core inflation is still headed in the wrong direction: up.

One country’s currency does not depreciate very often due to economic data released by another country, but this is not the case now due to the scale of the large inflation problem.

The stubbornly high inflation in the US increases the odds that the country’s central bank will raise interest rates even more aggressively than before. Next week, the US Federal Reserve is due to raise the benchmark interest rate by at least 75 basis points to 3.25 percent, if not more.

Pricing investments linked to the Fed rate indicates that investors believe that the US bank interest rate will eventually rise to four or even five per cent.

“Price will peak higher than expected a few months ago, and will stay there longer than initially anticipated,” said Audrey Childe Freeman, FX strategist at Bloomberg Intelligence. “At some point the market will focus on the next Fed session.” [of rate cuts] But that is out of reach.”

If the Fed rate goes to 4.5 next year, as investors expect, that’s much higher than the probability that the Bank of Canada will go, which is why the gap in the two countries’ currencies is widening.

How does price hike affect the currency?

All things being equal, higher prices increase the value of a country’s currency because it makes it more profitable for foreign investors to park their money there: they will get a higher return for doing so. This general rule is more applicable than usual at the moment, because the US dollar is seen as the safest place to keep your money in times of uncertainty.

“There has been a huge influx of money into the US dollar because it is the pre-eminent safe haven and because the US economy is much stronger than anywhere else,” says Adam Patton, senior currency analyst at ForexLive Exchange.

Looney looks like it’s diving a swan because just about everything not a dollar is sinking right now, he says. Compared to other currencies such as the Euro, the British Pound and the Japanese Yen, the Canadian Dollar has gained strength this year. But it drops by the benchmark most Canadians measure it against: the US dollar.

Loonie looks weak against the USD, but is strong elsewhere

Another reason for the relative weakness of the Canadian dollar is the weak prices of commodities such as oil and gold, as the outlook for the global economy is getting worse.

“Commodities are weak, in large part because the market is (finally) beginning to recognize the fact that the outlook for global demand looks bleak,” says Biban Rai, foreign exchange analyst at CIBC. “This is important for a major agent like the Canadian dollar.”

The price of a barrel of oil has lost about $30 since June, which in itself would be more than enough to drag the Canadian dollar down.

But this selling pressure is getting worse because of what investors think central banks will do. While the Canadian central bank is also aggressively raising interest rates, the pain in the country’s housing market and consumer spending will likely force the central bank to stop rising soon.

“Up until last week, the market was saying that both would stop at around four per cent,” Patton said. “Now the market is saying the Fed can go up, but the Bank of Canada may not be able to.”

If that happens, it’s a recipe for making more money in the US dollar, which is why Patton wouldn’t be surprised to see the Canadian dollar drop below 73 cents by the end of the year.

“Canadians may not fully appreciate how bad things are,” he said.