Sep 19, 2022
Loonie struggles: This is what is dragging the Canadian dollar lower
A stronger U.S. dollar puts pressure on markets around the world: Research analyst
The Canadian dollar’s drop against the greenback is partially due to close ties with resource and commodity prices, according to one foreign exchange strategist, causing it to be sensitive to swings in global growth and equity market trends.
The Canadian dollar fell below the 75 cents U.S. mark Monday morning to the lowest point since early November 2020. Shaun Osborne, a chief foreign exchange strategist at Scotiabank, said in a note to clients Monday the current risk backdrop and U.S. equity market trends appear to be the most significant factors driving the downward performance of Canada’s currency.
“The Canadian dollar generally is treated as what's termed a high beta currency. That's to say it's been a resource-based economy, the Canadian dollar and its linkages to resource prices [and] commodity prices are sensitive to swings in global growth or the outlook for global growth,” Osborne said in a phone interview Monday morning.
Equity market trends are an important benchmark of investors’ feelings about the growth outlook, Osborne said.
“So we've seen weaker stocks or stronger stocks generally have been quite an important influence on the Canadian dollar,” he said.
On a rolling one-month basis, Osborne said the Canadian dollar was correlating around 82 per cent Monday morning with U.S. equity markets.
“The risk backdrop, or equity market backdrop, is quite a powerful influence on the [Canadian dollar’s] performance,” he said.
Among the major global currencies, Osborne said the loonie is among the most correlated with equity markets.
Monetary tightening continues to be a significant factor behind the risk backdrop in U.S. equity markets.
Interest rates in the U.S. have risen quickly, Osborne said, given “sticky inflation numbers.” Amid persistent inflation, Osborne said there will likely be another aggressive interest rate hike from the U.S. Federal Reserve this week, something that may keep the greenback elevated in comparison to Canada’s currency.
“We have seen interest rate differentials move more in the U.S. dollar’s favour. At the margin, that's going to keep the U.S. dollar supported as well,” he said adding that markets are expecting the Fed to maintain its hawkish posture.
Markets are pricing in a further three-quarter of a percentage point increase from the U.S. Federal Reserve later this week.
Another key factor when evaluating the performance of the loonie against the greenback is the U.S. dollar’s attractiveness during market downturns, Osborne said, as it acts like a “refuge currency.”
“In times of equity market weakness, people will tend to flock towards the U.S. dollar for refuge and liquidity, so the effect on the Canadian dollar is kind of amplified by that,” he said.
Monday’s drop, however, may not be reflective of the loonie’s performance over the longer-term.
“More often than not, we measure the Canadian dollar in terms of its performance against the U.S. dollar. One of the perhaps more overlooked aspects of price action this year has been the fact that amongst the major currencies, the Canadian dollar has been one of the better performers overall, in year-to-date terms, at least,” Osborne said.