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What Happens when the Loonie shoots past Parity with the Greenback?

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Alex Carrick

Positions:
Alex Carrick is Chief Economist for CanaData, Reed Construction Data’s Canadian economic forecasting and statistical service.

Economists

Once again, the Canadian dollar is flirting with U.S. dollar parity. What will be the consequences if the loonie shoots past parity with the greenback? How much worse (or better) will things get?

Once again, the Canadian dollar is flirting with U.S. dollar parity. What will be the consequences if the loonie shoots past parity with the greenback? How much worse (or better) will things get?

Which comes first, the U.S. dollar fall or the increase in the world price of oil? The answer is far from clear. There are logical arguments that explain the weakening in value of the U.S. dollar. First among these is the $1.4 trillion fiscal deficit that Washington is wallowing in.

There is also the fact that the retreat into U.S. dollar holdings is no longer as important as it was in the final quarter of last year. The U.S. dollar received support while risk aversion was seen as a top priority. Now investors are moving into other assets such as stocks and commodities.

Recovery in China is already helping to drive up some commodity prices. There are still large excess inventories of oil stored in tanker fleets, but this may turn around relatively quickly. China is already moving more cars off showroom lots each month than is the case in the U.S.

Canada is a resource rich nation. Strength in raw materials, as well as having an economy that survived the recession better than most, is lending support to the loonie. Canadians should take pride in the fact that a strong currency is equivalent to receiving a high mark in an international comparison of economies. That’s a good thing. But there are side effects on a sectoral basis.

(1) You and me and retailers: We’ll be able to buy things from the U.S. even cheaper than now. That’s if we go shopping south of the border or if we order things from the U.S. over the Internet. Lower-priced-imports will also be an incentive for Canadian distributors and producers to keep their prices down at home. This will force belt-tightening back through the supply chain.

Some of the goods that retailers and wholesalers import for sale will fall in price. And there will be some sales leakage from day-trippers going across the border. The total net effect should be a downward bias on the inflation rate, with one caveat. Commodity producers around the world will be striving to prop up their prices to maintain or expand upon currency-adjusted returns.

(2) Canadian commodity producers: All other things being equal, their profits will come under pressure. Their operating expenses are in Canadian dollars but the price they charge is almost always set in U.S. dollars. There is speculation that some countries (e.g., Middle-eastern oil producers) might like to see energy commodity prices set according to a basket of currencies.

In the agricultural sector, world demand is a bigger factor than U.S. demand alone. However, wheat is priced in Canadian dollars and that will hurt some sales. Fruits and vegetables are being imported from Florida and California cheaper than before. Livestock sales are being hurt by new U.S. country-of-origin labeling requirements (COOL) to at least the same degree as by the rising exchange rate. Finally, some dairy products may be allowed into Canada at lower prices.

(3) Tourism: Canadians will enjoy bargains traveling to the U.S. On the other hand, Americans will have even less reason to come to Canada. This will add to the difficulties of our accommodation sector which is already struggling under the handicap of new U.S. travel rules. These require American citizens, once they have exited the country, to show proof of citizenship on their return. Most Americans are not yet familiar with the process of acquiring a passport.

(4) Manufacturers: This is the sector of the economy that usually gets the most attention when it comes to currency swings. Realizing export sales becomes more of a challenge with each tick upward of the loonie. But there is a positive aspect to be realized from purchasing cheaper imported machinery and equipment that often comes from the U.S. This will help firms realize the productivity gains that they will need to keep competing in this new highly integrated world.

For the construction industry, there is also the building product sub-category of manufacturing to consider. BPMs are finding it harder to sell their product into the U.S. On the other hand, the revenue that they do realize contributes more to their head offices if such corporate headquarters lie south of the border. BPMs are already suffering on another count when it comes to selling product into the U.S. - the Buy American provisions of government purchasing policies. This is particularly cutting into Canadian participation in U.S. Stimulus Package construction projects.

(5) Bank of Canada: The BOC’s stated goal is to achieve a +2.0% year-over-year inflation rate. But its actions with regard to interest rates can have quite an impact on the Canadian dollar. Higher interest rates attract capital which drives up the value of the currency. The BOC has already expressed worry that the high-valued loonie may slow recovery inordinately in this country. This may be an incentive to keep interest rates low for longer than would otherwise be the case. If nothing else, the volatility in the country’s currency makes it harder to plan and budget. Whatever stability can be provided through interest rate policy will be welcomed.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News. Mr. Carrick also has a lifestyle blog that can be reached by clicking here.

by Alex Carrick

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