The winners and losers as the loonie keeps flying south
The Canadian dollar looks set to take a dive this summer, or at least to remain weak for some time to come.
Cyclical and structural factors point to Canadian rates falling earlier and faster than in the United States, meaning that now is the time to trim loonie exposure (although Government of Canada bonds do look appealing for domestic investors). That presents a risk to inflation, and consumers would feel it in the price of imported items — the Bank of Canada’s cut pacing may depend on the degree of pass-through from the exchange rate to consumers.
But rate moves always generate winners and losers, and a weak Canadian dollar would support exporters, could improve competitiveness and might help reverse the trend of declining net investment.
On both the activity and inflation fronts, the case for rate cuts has become much stronger in Canada than it is stateside. Real incomes are declining in Canada, real gross domestic product (GDP) growth is running at one per cent (versus more than 2.5 per cent in the U.S.), and elevated interest rates are weighing on investment and productivity.
Meanwhile, headline inflation is within the target band, and core measures are falling fast — in stark contrast to the “stall” in disinflation that U.S. investors are so worried about. What’s more, elevated shelter inflation measures, which governor Tiff Macklem loves highlighting as a reason for caution, will fall as soon as the Bank of Canada eases rates.
This all points to a widening of the negative spread between U.S. and Canadian rates. Currently, the yield on the two-year Government of Canada bond stands at 4.22 per cent, 47 basis points below the U.S. equivalent at 4.69 per cent. In the (extremely plausible) scenario that markets price
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