Skip to main content

The Canadian dollar fell almost a full penny against the greenback Wednesday after the Bank of Canada removed its mild monetary tightening bias. The engrossing asset price tug-of-war between the loonie and commodity stock prices appears, for now, to be moving in the direction of a lower currency price.

This chart shows a divergence in the historically close relationship between the S&P/TSX Materials Index and the value of the Canadian dollar. In October 2012, materials stocks began moving lower while the loonie remained stable.

It's no surprise that commodity prices and the Canadian dollar are usually tightly linked. For starters, American companies need to exchange hundreds of millions of U.S. dollars into loonies each day to pay for the 2.4 million barrels of oil imported from Canada. All domestic exports create demand for Canadian dollars and result in upward pressure on the currency price.

I expected the divergence between materials stocks and the loonie to narrow (ie. the lines on the chart would move towards each other) but wasn't sure whether materials prices would rise or the dollar would fall.

The Bank of Canada's change in stance was an admission that the previous monetary tightening bias (towards higher interest rates) was misplaced. This suggests that the Canadian dollar was overvalued – the currency was higher in part because investors believed interest rates were going higher. (Higher rates attract foreign investment, which supports currency values).

If the dollar was overvalued previously, this implies that the divergence on the chart will be corrected by the domestic currency falling. The other way – materials stocks rising to meet the currency price – would have been more lucrative for equity investors.

A weaker loonie would be good news for the Canadian economy, particularly non-resource sectors such as the automotive industry which are dependent on exports. For the equity market, not so much.

To view the chart on mobile devices, click here: http://tgam.ca/Dvon

Follow related authors and topics

Authors and topics you follow will be added to your personal news feed in Following.

Interact with The Globe