Why the loonie is still flying high despite the economic storm clouds

Canada’s economic performance hasn’t been very good lately—but compared to the rest of the world we look like a safe harbour

Loonie coins

(Bayne Stanley/CP)

Iraq, one of the world’s biggest oil producers, will increase its exports of the stuff by about 5% this week, Bloomberg reported over the weekend. State-run Northern Oil Co. worked out its differences with the Kurdistan Regional Government, the semi-autonomous authority that had closed the pipeline Northern Oil was using to get crude from three fields to market.

As one would expect, global prices slumped on the news. A three-week rally that saw West Texas Intermediate surge to more than $48 from about $40 at the start of the month ended unceremoniously on Aug. 22.

Noteworthy, however, was the reaction of the Canadian dollar: its value barely changed. That’s not what is supposed to happen. Everyone knows the Canadian currency is lashed to oil. When prices fell, the loonie should have descended. The tight link between the Canadian dollar and crude is broken.

Chart showing the relationship between the Canadian dollar and energy prices.

The blue line above is the average weekly change in the Canadian Dollar Effective Exchange Rate Index, a weighted average the loonie’s value against the currencies of Canada’s six biggest trading partners. The red line is the Bank of Canada’s index of energy prices. Oil prices sank in July, as the central bank thought they might. Policy makers might have hoped the currency would sink, too. They have been leaning on the benefits of a weaker exchange rate to support their thesis that Canada’s economy is destined to rotate to manufacturing and non-energy exports. But any exporter trying to compete solely on price this summer got no help from the exchange rate. The currency has traded between about 76 U.S. cents and 78 U.S. cents all year.

Many on Bay Street have struggled to explain the currency’s buoyancy. The loonie touched its high for the year earlier this month even as negative economic indicators piled up. The trade deficit widened to a record, suggesting a drop in demand for Canadian goods and the currency needed to buy them. “To all but the loonie, Canada’s economic malaise has become increasingly apparent,” the Globe and Mail wrote on August 8. The article included three economists—from BMO Nesbitt Burns, Gluskin Sheff + Associates, and Bank of Nova Scotia—and all bet the currency was due for a fall because the data didn’t jibe with a stronger exchange rate. The currency was trading around 76 cents when that article was published and climbed above 78 cents on Aug. 18. The exchange rate lately has been hovering around 77 cents. That’s not much of a decline.

Currency markets are a torrent of conflicting pressures in this post-crisis era, making the old rules of thumb poor guides. It’s true that Canada no longer is a shining star of the global economy. But nor is it any danger of collapse—which makes it look pretty good against post-Brexit Britain and the European Union. The International Monetary Fund predicts Canada’s gross domestic produce will expand almost 2% next year, faster than every other Group of Seven country with the exception of the United States. Currency traders care more about the future than the past.

Dated economic indicators are relevant only because they help predict whether central banks will raise or lower interest rates. The Bank of Canada has made it pretty clear that it sees no reason to cut interest rates. With borrowing costs either near zero or negative in the biggest advanced economies, that makes Canada a relatively attractive place to stash money. The number of countries rated “AAA” by all three of the main credit rating agencies is down to four: Canada, Denmark, Norway and Luxembourg. International purchases of Canadian securities were near record levels in the second quarter, Statistics Canada reported on Aug. 18.

Chart showing net foreign investment in Canadian securities

In the aftermath of the financial crisis, Canada became a haven for risk-averse international investors. Demand for Canadian bonds and other financial assets drove the currency to par with the U.S. dollar. That won’t be repeated. The U.S. economy is relatively stronger and the Federal Reserve’s next move probably will be to increase interest rates. But Canada still is very attractive for low-risk investors who would like to earn a little money on their investments. That will put upward pressure on the currency, offsetting negative economic news. Non-Canadians added more than $80 billion to their portfolios in the first half of 2016, the most ever over a six-month period, according to National Bank of Canada senior economist Krishen Rangasamy. “Strong portfolio inflows explain in part the resilience of the Canadian dollar amidst persistently weak oil prices,” Rangasamy said in a research note.