Heading down to Buffalo for some Black Friday deals or to see the Bills beat the San Francisco 49ers this weekend?
You could be in for a rude awakening: Your loonies won’t go nearly as far as they did this time last year. Or, for that matter, even a few months ago.
You can thank a sputtering Canadian economy, interest rate cuts by the Bank of Canada, household debt and, well, U.S. president-elect Donald J. Trump, currency exchange experts and economists say.
Just over two months ago, the loonie was worth 74.51 cents (U.S.). Earlier this week, it had plunged as low as 70.54 cents, before recovering to 71.38 Thursday afternoon.
A big driver of the drop this year, said CIBC chief economist Avery Shenfeld, has been the growing spread between interest rates in Canada and the U.S.
With interest rates higher in the U.S., investors looking for better returns park their money into U.S. investments, fuelling demand, and price, of the greenback, Shenfeld explained.
“It’s the flow of funds. People are looking for those higher yields,” said Shenfeld. “They just look more attractive.”
The Bank of Canada’s key overnight rate has been cut four times this year, from five per cent to its current 3.75 per cent.
The U.S. Federal Reserve’s fed funds rate — the American equivalent to the Bank of Canada’s overnight rate — is currently set at a range of 4.5 to 4.75 per cent, meaning the spread between Canadian and U.S. rates is as high as a full percentage point.
A year ago, before the Fed and the Bank of Canada started cutting to stimulate their respective economies, the overnight rate was at five per cent, and the Fed Funds rate was set at a range of 5.25 to 5.5 per cent, meaning the spread was as low as a quarter of a percentage point.
The Bank of Canada raised interest rates 10 times between March 2022 and last summer in a bid to wrestle inflation down to its two per cent target. Inflation peaked at 8.1 per cent in June, 2022 as the Canadian economy opened up from COVID-related restrictions. In October, Canada’s annual rate of inflation was at two per cent, right in the middle of the Bank’s 1 to 3 per cent target range.
The theory is that by making it more expensive to borrow money, consumers and businesses will spend less, driving down prices and slowing the economy.
Now, as the economy slows and inflation has been heading mostly downward, the Bank is taking the reverse approach, trying to stimulate growth by cutting rates.
And with the U.S. economy continuing to show signs of strength, there’s less reason for the Fed to cut as quickly as the Bank of Canada, said Bipan Rai, managing director at BMO Global Asset Management.
But, Rai said, household debt levels are also higher in Canada, which also means the Bank of Canada has even more reason to ease interest rates.
“It’s certainly a more dynamic economy in the U.S., relative to Canada,” said Rai, a long-time foreign exchange strategist. “Both central banks are reacting not just to that, but also the household debt dynamics. Over the long term, that’s your exchange rate story right there.”
With Trump threatening to impose a 25 per cent tariff on all imports from Canada and Mexico once he takes office in January, the loonie’s prospects took another hit, given the potential damage to the economies of both nations.
But Rai pointed to the reality of Trump’s first term in office as reason for optimism, both for the Canadian economy and, by extension, the loonie.
In May, 2018, Trump introduced a 25 per cent tariff on steel imports, and a 10 per cent tariff on aluminum. The U.S. agreed to remove the tariffs on Canadian and Mexican steel and aluminum imports a year later.
“The steel and aluminum are really the closest parallel,” said Rai.
Still, knowing Trump’s penchant for sudden policy swings, predicting what will actually happen isn’t easy, CIBC’s Shenfeld said.
“If you can tell me what Donald Trump will actually do, I could give you a better idea of where the loonie will go,” said Shenfeld. “The truth is that a lot of it depends on whether we escape those tariffs.”
