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Canada: Loonie Can Rise As U.S. Interest Rates Fall

by: Geoffrey Caveney

A recent article argued that the Canadian dollar historically tends to decline as U.S. interest rates fall.

However, a long-term view shows that the loonie has strengthened over the past 20 years while U.S. rates and bond yields have fallen dramatically.

While U.S. rates and the Canadian dollar both declined in 2008, on the contrary in 2009-2012, the loonie strengthened in the face of low and falling U.S. rates.

A combination of specific conditions in 2007-2008 set up the crash of the Canadian dollar in late 2008, such as a commodity market peak in mid 2008.

These conditions today are distinctly different from 2007-2008, in particular commodity prices and the loonie are much lower to begin with, so I do not expect another Canadian dollar decline in 2019-2020.

A recent article argued that the Canadian dollar (FXC) and Canadian stocks (BBCA) (EWC) (FCAN) (FLCA) (HEWC) (QCAN) historically tend to decline as U.S. interest rates fall. The article cited the examples of steep declines in 2001 and 2008 as evidence for this argument.

However, looking at a more complete long-term view of the overall trend and direction of the Canadian dollar, compared with U.S. interest rates, leads us to a different conclusion:

While U.S. interest rates and bond yields have steadily and steeply declined over the past 20 years, during the same time period the loonie has not fallen along with them. In fact, on balance, the Canadian dollar has somewhat strengthened over this same period.

Here's a chart of the long-term performance of the Canadian / U.S. dollar exchange rate and the U.S. 10-Year Treasury bond yield from 1999 to the present. The red line is the Canadian dollar, and the blue line is the U.S. bond yield:

As you can clearly see in the chart, over this 20-year period, U.S. bond yields have declined by a staggering 57%. But the loonie, after some long up and down periods, is still today 16% stronger than it was 20 years ago.

Thus, somehow, somewhere, at some time, the Canadian dollar must have not followed U.S. rates lower, but rather held its value or risen even in the face of lower rates.

Now it's true that there have been certain time periods when the loonie and U.S. rates and yields declined and fell in tandem. Most clearly, the global financial crisis and Great Recession of 2008 was one of those times, as Danielle Park's article points out.

However, in the following recovery period from 2009 to 2012, on balance, U.S. rates and yields stayed low and eventually fell even lower, but the Canadian dollar did not follow them at all. On the contrary the loonie rallied sharply, almost all the way back to its peak levels of late 2007.

Here's a chart of this period, from mid-2009 to mid-2012, when U.S. rates fell steeply for a prolonged period, but the Canadian dollar held its value and even strengthened. Again the blue line is the U.S. bond yield and the red line is the loonie:

Here we see a 64% decline in U.S. rates and yields over a three-year period, but it didn't drag the Canadian dollar down with it: On the contrary, the loonie strengthened as much as 17% and ended the whole period 9% higher than it had been at the start of the period.

Of course there are other factors that explain these dramatically different performances in different periods. We cannot expect and do not have a one-size-fits-all correspondence between the Canadian dollar and U.S. rates. One set of financial conditions may drive both of them lower, but other conditions produce lower U.S. rates but a stronger loonie.

So yes, in a catastrophic global financial crisis, such as the world experienced in late 2008, U.S. rates will fall as the Fed and almost all global central banks cut rates and enact monetary easing policies. At the same time, the value of the U.S. dollar did not crash during this crisis: On the contrary, the U.S. dollar strengthened as global investors went to cash and treated the dollar as a relatively safe haven asset to hide out while almost all other asset prices were crashing.

Meanwhile, commodities had been riding high at the peak of a historic bull market until the middle of 2008, so they also were ripe for a crash, just like stocks and other assets at this time.

So, with the U.S. dollar stronger and commodities weaker, of course this combination was devastating to the value of the loonie, considering Canada's heavily commodity-based economy. It's these factors that explain the decline of the Canadian dollar in 2008, not the falling U.S. interest rates themselves.

On the other hand, in the 2009-2011 period, while U.S. rates continued to stay low and then went even lower, the other factors had changed. The U.S. dollar got weaker and commodity prices soared. This inflationary combination boosted the value of the Canadian dollar significantly. Again, it was not the U.S. rates, but the direction of the U.S. dollar and commodity prices that were the key factors in the performance of the loonie.

How 2019 Is Different From 2007

I don't expect a repeat now of the Canadian dollar's plummeting value like in 2008 because in a number of critical ways financial conditions today are quite different from the situation in 2007-2008:

In 2007-2008 the commodity market and the loonie itself were already at the peak of their strength, at or near all-time record highs. The trend was so strong that the loonie itself was named the Canadian Newsmaker of the Year for 2007 by the Canadian edition of Time magazine:


But now, things are very different. Commodity prices may have bounced and rallied somewhat in 2019, but the long and deep commodity bear market from 2011 to 2015, followed by overall tepid performance since then, has commodity prices in general at not even half the level of their 2011 peak, and even farther below their 2008 peak:

To put it simply, commodities and the loonie are not as likely to crash in 2019-2020 as they were in 2007-2008, because they are not perched on such a high and precarious peak as they were back then.

It's true that the immediate perspective for the Canadian dollar may well be dependent upon the performance of the global economy: In general, a global recovery will tend to boost the loonie, while a global slowdown will tend to hold it back. However, with the value of the Canadian dollar only at the relatively low level of $0.76 U.S. dollars to begin with right now, it likely just doesn't have all that much farther to fall, unlike in 2007-2008.

The loonie has more or less traded around the value of $0.75 over the past several years, since the bottom of the commodity bear market in 2015, only rising or falling a couple cents here or there since then:


In the long-term perspective, whether the Canadian dollar's immediate next move is down to $0.73 and then up to $0.78, or up to $0.78 and then down to $0.73, doesn't necessarily have a drastic financial significance, unless you are a short-term currency day trader.

What's more important to long-term investors, in particular to commodity and precious metals investors, is whether the long-term direction of the loonie is more likely headed downward to $0.60, or rather headed upward to $0.90.

And considering the very low and subdued price levels of commodities and precious metals from 2015 up to today, together with the predilection of almost all governments and central banks around the world for monetary easing and currency devaluation, over the next five years I see commodity price inflation as a much more likely outcome than commodity price deflation. Therefore, I see the Canadian dollar on a medium- to long-term path toward $0.90 U.S. dollars as a much more likely prospect, rather than a decline toward $0.60.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.