Loonie Closing in on Parity as US Dollar Struggles

The Canadian dollar – referred to by Canadians as “the loonie” in homage to the water bird depicted on the back of the one dollar coin – is once again on its way to parity with its American cousin. The loonie did not even take time to celebrate the Canadian Thanksgiving this past weekend, gaining nearly a cent and a half since Friday to open at 97.13 cents US this morning. At this rate, earlier predictions that the loonie could equal the US dollar by the end of the year, are in need of an emergency revision.

With these recent events in mind, I can’t help but thinking that this feels very much like the fall of 2007 when the loonie last reached parity with the US dollar. Looking back, this event marked an extremely volatile period for not just exchange rates, but commodity prices as well, and it may be wise to review our history for clues as to what could be in store for us.

When I wrote about the loonie’s march to parity last November, oil prices were already nearing $100 a barrel. Oil continued to climb until later the following summer when the sub-prime fuelled recession took root and a dramatic reduction in demand saw oil peak at about $140 a barrel before falling off a cliff. But this time around – who knows?

Prices jumped from $71 a barrel late last week to more than $74 this morning, and with demand expected to increase as more of the world’s largest economies start to grow after nearly two years of contracting, it is likely that prices are only headed upwards. Gold prices too are on the move, breaking through the $1,065 an ounce mark for the first time earlier today as investors look for safer harbors in which to weather out the storm caused by the plummeting greenback.

Melvyn Boey – Merrill Lynch’s deputy director of Asian equity research – has gone on record saying that most commodities – especially oil and gold – will continue to gain over the next year. This is because these goods are priced in US dollars, and as long as the US dollar continues to lose ground to the other major currencies, we can expect commodities to increase.

All this makes Bank of Canada Governor Mark Carney’s job even more difficult. Canada is an exporting nation, relying heavily on a positive trade flow with the United States where it sells anywhere from 70 to 80 percent of its exports to its neighbor to the south. A weaker US dollar vis a vis the Canadian dollar makes exports from Canada even more expensive for American consumers at a time when consumers are under attack from many fronts including surging unemployment now at nearly 10 percent. This places the Bank of Canada under considerable pressure to maintain an interest rate policy that keeps the loonie weaker so that Canadian exports remain a bargain for those with US dollars.

Unfortunately for the Bank of Canada, it has already taken interest rates as low as they can practically go, yet the loonie remains on an upwards path. Meanwhile, the rest of the world is talking about inflation and the possibility of raising interest rates to deal with an expected surge in spending as government stimulus spending works its way through the economy.
Last time around in 2007, it took a global recession to halt the march of the loonie and commodity prices. What will it be this time?

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