The Canadian dollar fell to its lowest level in almost two years on Friday, as investors around the world surveyed the worsening outlook for the economy and ran toward the safety of the U.S. dollar.

The Canadian dollar was changing hands for as little as 75.15 cents US at one point on Friday morning. That’s the lowest level for the currency since October 2020.

The loonie was off by about half a cent from Thursday’s close, just the latest down day in a stretch of them for Canada’s currency. The loonie fell by more than a cent on Tuesday when data out of the U.S. showed the country’s core inflation rate is still going in the wrong direction: up.

One country’s currency doesn’t often plunge because of economic data coming out of another, but that’s not the case right now because of how big a problem inflation is.

High inflation in the U.S. increases the odds that the country’s central bank will have to raise its interest rate even more aggressively than it has been. The U.S. Federal Reserve is slated to reveal its latest interest rate decision next week, and investors are betting it will raise by at least 75 basis points to 3.25 per cent, if not more. 

Because inflation is proving to be so stubborn, investors think the Fed will ultimately go as high as four or even five per cent.

“Rates will peak higher than assumed a few months ago, and stay there longer than initially expected,” said Audrey Childe-Freeman, a foreign exchange strategist with Bloomberg Intelligence. “At some point the market will focus on the Fed’s next cycle [of rate cuts] but this is far off.”

Investors now expect the Fed rate to be at least 4.5 per cent by 2023, if not higher. That’s far higher than the Bank of Canada is likely to be able to go, which is why the gap in the two countries’ currencies is widening.

Rate hikes a factor

All things being equal, rate hikes are a positive for a country’s currency because it makes it more worthwhile for foreign investors to park their money there. That’s even more applicable than usual right now, because the U.S. dollar is seen as the safest place to keep your money during times of uncertainty. 

“There’s been an absolute flood of money into the U.S. dollar because it is the pre-eminent safe haven and because the U.S. economy is much stronger than everywhere else,” says Adam Button, chief currency analyst with foreign exchange firm ForexLive.

What’s happening to the loonie right now isn’t so much that it’s being dumped, but rather that everything that isn’t U.S. dollars is getting walloped, he says. Compared to other currencies like the euro, the British pound and the Japanese yen, the Canadian dollar is gaining strength. But because it’s mostly priced versus the U.S. dollar, it’s falling.

Another reason for the Canadian dollar’s relative weakness is softness in commodity prices like oil and gold, because outlooks for the global economy are getting worse.

“Commodities are weak, largely because the market is (finally) coming around to the fact that the prospects for global demand look bleak,” says Bipan Rai, a foreign exchange analyst with CIBC. “That matters for a key proxy like the Canadian dollar.”

The price of a barrel of oil has lost about $30 since June, which is more than enough to drag down the loonie by itself.

But there are even more reasons for the loonie’s weakness coming because of what central banks are doing. While Canada’s central bank is also hiking rates aggressively, the pain to the country’s housing market and consumer spending will likely compel the central bank be forced to stop hiking soon.

“Up until the last week, the market was saying both will stop at around four per cent,” Button said. “Now the market is saying the Fed can go higher, but the Bank of Canada might not be able to.”

If that happens, that’s a recipe for even more money to pour into the U.S. dollar, which is why Button wouldn’t be surprised to see the loonie dip below 73 cents by the end of the year.

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


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