The
Canadian dollar is threatening to hit the worst levels since May 2020 in what would be
a major range breakout. Aside from brief periods during covid and the oil price
collapse in 2016 (both less than a month long), this would be the lowest level
since 2003. I expect this period of weakness to be longer lasting as the three
legs of the Canadian economy – housing, immigration and resources extraction –
are all impaired.
The best-case
scenario for the Canadian dollar
Before I get into the base case for the loonie, it’s not set in stone that it will fall further, at least not in the short term.
For now, all eyes
are on the US election and Kamala Harris would undoubtedly be better for the loonie.
Trump who would renegotiate the USMCA once again in 2026 in a move that would
put a cloud over CAD. Moreover, broader trade and tariff worries would cool
global trade and international investment – both Canadian strengths.
Equally
important in the short term is China fiscal stimulus. At any point in the next three
weeks, we could see China’s rubber stamp parliament announce fiscal measures.
At minimum, I’d like to see $1.4 trillion in new spending (10 trillion yuan),
or around 7% of GDP. Something is coming but that might be optimistic and China
might want to see how the US election settles before deciding on a course of
action.
The base
case is the downside scenario
Trump is more-likely
to win and China is likely to under-deliver. That’s the base case, then you
turn to the domestic economy – it’s slowing and the Bank of Canada has rates
way too high at 3.75%. The housing and jobs markets are worsening. Canadian
retail sales looked good on the surface but autos are masking weakness elsewhere
and I don’t think the pop in autos is sustainable. We’re probably headed for an
ugly outcome in Toronto condos.
The Bank of
Canada should continue cutting rates rapidly but they will likely prove overly
cautious and that will prolong and deepen weakness. I don’t foresee a recession
but growth will be slow in 2025 and 2026. As that becomes increasingly clear,
the loonie will make its way to 1.42 or
68-cents.
USD/CAD monthly chart
Politics
I think
some Canadian dollar bulls are hanging their hopes on the idea that a change in
government would lead to a rapid rebound in the currency. That won’t be the
case.
Like with the UK election, the market has already priced in a change in
government by this time next year. If that’s sooner, it’s something of a
positive but nothing that will change the trajectory. It’s going to take time
to turn anything around.
To hammer
home the point, the Conservatives appear to have shifted stances this week,
announcing a removal of GST on new home sales under $1 million. Previously,
they were taking a line that campaign promises should be made in campaign. This
indicates either that 1) they believe that we’re on the brink of an election 2)
they’re going to pressure the housing market to further hurt the Liberals.
How are
they squeezing them? They basically just cut the price of a new home by
5%, but only if you wait until there is a new government to buy. So why would you buy
now? Expect new home sales to slide even further in light of this announcement.
I suspect the thinking is that Conservatives hope to engineer a bottom in
housing when they arrive in power. The good news is that they have some fiscal
room as Canadian deficits are running much smaller than in the US.
Immigration
Canada has
several options to keep home prices high: 1) Cut rates back to rock-bottom
levels, 2) Offer fiscal support 3) Add more people.
I don’t see
any real help on any front. Rates are coming down but too slowly and 5-year
rates have moved up 30 basis points in the past month, which pressures
mortgages higher. The fiscal side is now likely a drag due to the Conservative
announcement and now immigration targets will lead to a declining population in
2025 and 2026.
The three
legs of Canadian economic growth this century have been housing, population growth, natural resources. All three are impaired to some degree,
as it’s never been harder to extract natural resources in Canada.
USD Side
You can’t
ignore the US dollar side of the equation. The US dollar is broadly stronger
over the past six weeks as the market prices out the likelihood of a US hard
landing and economic data rolls in that shows surprising strength after a weak
summer period.
In
addition, the market is sensing a Republican sweep and tax cuts, growth and
deficits to go with it. Those are US dollar positive, at least until the bill
is due.
