Could this be the week we finally see the Canadian dollar capitulate to the forces of gravity?
The currency has been in retreat now for the better part of a month, slipping from just above parity with its U.S. counterpart to around 97 cents (U.S.).
While that move isn't insignificant – and, indeed, reflects increased concerns about the tepid pace of the Canadian gross domestic product growth as well as the country's record-high current account deficit, both reported by Statistics Canada last week – we haven't yet seen the kind of retreat that will convince the currency market that the loonie is ready to give up on parity just yet.
So far, this has just been one of those occasional little dips within the currency's trading range of 95 cents to $1.03 in which it has resided for the better part of three years.
But by all rights, there should be more to come. The dollar's underlying economic fundamentals increasingly justify a more significant correction.
"We expect a lot of downward pressure on the Canadian dollar, which could bring the loonie down to a level of 90 to 92 cents within 18 to 24 months – or even earlier," said a report Friday from veteran economist Clement Gignac, who recently took over as chief economist at Industrial Alliance in Quebec City.
Last week's balance-of-international-payments report from Statscan showed that the country's current account deficit for all of 2012 was $67-billion (Canadian) – equivalent to nearly 4 per cent of gross domestic product. Mr. Gignac contrasted this with the 3-per-cent-of-GDP surplus in the current account in 2008, when the loonie was in the midst of its first sustained stint at parity with the U.S. dollar in more than three decades.
When your international payments are that much in deficit, it means a whole lot more money is flowing out of the country than into it; and that means more Canadian currency being sold than being bought. Big current account deficits are supposed to drag down a currency.
But the current account has been in substantial deficit for nearly five years now, and still the Canadian dollar has ignored this reality and held its ground. How?
Krishen Rangasamy, senior economist at National Bank Financial, noted that the inflows of investment money into Canada – foreign investors parking funds in Canadian securities, mostly bonds and money-market instruments – have been offsetting the imbalance in the current account and keeping the dollar afloat.
But these investment flows into the Canadian currency are generally much more volatile over the short term than the current account, and are susceptible to changing direction quickly – especially if, say, a market's economic story has weakened and its prospects for relatively strong interest rates have evaporated. (Yes, I'm looking at you, Canada.)
"The short-term nature of those easily reversible inflows just makes the loonie vulnerable to a correction, particularly if there's a significant shift towards risk aversion," he wrote in a research note last week.