Weekly Sound Bite: The loonie goes out like a lion

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It took longer than I expected, but the loonie is now trading about one U.S. cent higher than when Justin Trudeau took over as Prime Minister on November 4th of last year. On Thursday the Canadian dollar was worth 77.11 U.S. cents according to Thomson Reuters data. So can Justin Trudeau and his Finance Minister Bill Morneau take credit for the loonie's comeback?

A number of factors drive a country's exchange rate, including interest rates.

In terms of interest rates, it appears that the Canadian bond yields may have put in a meaningful floor in February. Although U.S. bonds also put in a floor that month, Canadian bond yields have gone up a bit more. For example, the 5-year difference between U.S. and Canada 5-year bond yields was about 0.63% in favour of Treauries on February 11th. When Trudeau took over last November, the spread was 0.68% in favour of the U.S. It now stands at about 0.59%. While the change may appear small, for currency traders it is the trend which is important. On that front, the move in yields favours the loonie over the greenback. You can track Canadian and US bond yields on a nice table provided by the Financial Post.

Another factor foreign exchange traders pay close attention to is the price of oil, and Canadian crude also appears to have put in a meaningful floor during the winter. The Canadian Crude Index is up more than 60% from its January low. However, it is still lower than it was when the Trudeau government took power.

Given that the Canadian currency has outperformed oil, the outlook for interest rates appears to be dominating. It is probably a reasonable assumption that Mr. Trudeau and his Finance Minister have done much of the heavy lifting to pull interest rates up from their abnormally low levels. Consequently, the Liberals probably can take some credit for a stronger domestic currency.

Of course, there will be those who fret over a stronger currency as there are always winners and losers from foreign exchange rate moves. I would argue that at this point around current levels, the winners far outnumber the losers. In particular, Canada's poor will finally get some relief from food inflation which accompanied the weaker currency. Progressive politicians in particular should be mindful of this group when tempted to decry a stronger loonie.

Moreover, given how the nature of manufacturing has changed over the past 20 years, it is not clear that a 70 or 60 cent loonie will provide the boost that it once did to the sector. Truly global service and manufacturing companies need to source inputs and talent from around the world. They also need to be able to compete for Canadian graduates with global competitors. A stronger loonie helps their competitiveness on that front.

Listen to Ted Dixon on Roundhouse Radio FM 98.3 every Thursday for his weekly financial markets commentary at 7:30 am Pacific Time. If you missed the live broadcast, catch the replay for this week here: http://bit.ly/234UyeS.


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