Once flying high among currencies, loonie faces downgrade to 88-cents, says bank

OTTAWA – The humbling of the once high-flying Canadian dollar has only just begun.

It’s been 10 months since the loonie last enjoyed parity status with the U.S. dollar, but analysts say Canadians should not expect a rebound any time soon. They forsee the currency falling through the 90-cent US floor.

U.S. investment banker Goldman Sachs is the latest financial house to sell the loonie short, forecasting the currency to coast into the 88-cent range next year. That is an even gloomier outlook than the one issued by the TD Bank a few months ago, which predicted it near 90 cents by the close of 2013.

The loonie closed up 0.08 of a cent at 94.46 cents US on Thursday on the news that Canada’s current account deficit had narrowed. It may gain a little more lift Friday if Statistics Canada reports, as expected, a healthy 2.5 per cent advance in the economy for the third quarter.

But these temporary recoveries are fooling no one — the loonie has lost about seven per cent in value from the beginning of the year and fundamentals point to further deterioration.

The Goldman Sachs prediction would see the loonie falling another seven per cent.

“I do believe the glory days for the Canadian dollar are likely behind it,” says Doug Porter, chief economist with the Bank of Montreal.

“Does that mean we’re never going to see parity again? I wouldn’t say that. I just think it got a little too big for its britches (because Canada) was seen as a golden child relative to other industrialized economies, but that’s started to fade.”

Porter believes 88 cents is a reasonable target for the loonie next year, although he expects a bounce in 2015 if the Bank of Canada beats the U.S. central bank to the punch in starting a new tightening cycle on interest rates.

TD Bank chief economist Craig Alexander also expects the currency to continue weakening into next year as all the advantages that Canada once enjoyed over the U.S. have narrowed or reversed.

“Concerns about U.S. debt has diminished, Canada’s economic outperformance has diminished, commodity prices have come down, bond yield spreads are going to get smaller, so the direction of the dollar is down,” he said.

Canadians should also expect more volatility in the loonie, with periods where it is soaring above its fundamentals and periods where it will be well below.

But make no mistake about it, say the analysts, the new normal for the Canadian dollar is 90 cents US, not parity.

Economists have noted for years that, in terms of purchasing power, the loonie was never close to parity — a truer value was 85 to 90 cents.

The telltale indicator was that while the loonie floated well above its so-called purchasing power, leading to a significant price gap that appealed to cross-border shoppers, in terms of the current account — the broad balance of trade in goods, services and capital flows — Canada has been in a deep hole since 2008.

The current $60-billion-plus annual deficit, including slowing capital flows into the country, was a key reason cited by Goldman Sachs in its analysis.

Porter notes that Thursday’s positive news on the current account still leaves the country running a negative balance, worth about three per cent of its total economic output, which is a clear sign something is amiss in the valuation of the currency.

Analysts believe the U.S. Federal Reserve will start “tapering” its stimulus bond purchases early in 2014, which should further strength the U.S. greenback.

Meanwhile, Goldman Sachs notes that the Bank of Canada has gone the opposite direction, dropping its 18-month long tightening bias.

“All told, there are a number of reasons why the Canadian dollar has scope to weaken,” Goldman Sachs reasned.

“Some of these have been a factor for some time, but the notable weakening in the external balance, the gradual shift in the (Bank of Canada) communication and the prospect of Fed tapering and the associated risks all suggest that 2014 may be the year when the (Canadian dollar) weakens more materially after many years in narrow trading ranges.”

But it’s good news as far as the Bank of Canada is concerned, says Alexander, as it has conceded that the strong dollar was at least part of the problem behind manufacturing’s declining profile in Canada.

“I think the Bank of Canada will be pleased because it will improve the export competitiveness and raises the probability of getting the transition of growth in the economy toward exports and investment that it has been calling for,” he said.