A curious situation has been unfolding with the Canadian dollar recently.
In spite of indications that the economy is deteriorating, the currency has been appreciating, not depreciating, increasing by 3 percent against the U.S. dollar since President Donald Trump’s Liberation Day.
This is not the typical behavior, yet some analysts believe this phenomenon is more than a mere temporary fluctuation.
Desjardins Group anticipates that this divergence will continue to expand in the upcoming months, projecting the loonie to reach 74 cents U.S. by the end of this year and nearly 77 cents U.S. by the conclusion of the next. It was trading at 73.08 this morning.
The prediction is predicated on the U.S. dollar losing its strength rather than the Canadian dollar gaining it, according to Mirza Shaheryar Baig, a foreign exchange strategist at Desjardins. The loonie’s performance against other major currencies has not been impressive.
“Overall, a robust loonie is a consequence of a shift in global capital flows resulting in a generally weaker U.S. dollar,” he stated.
Since Liberation Day, the U.S. dollar has developed a positive correlation with stocks.
“In other terms, it has forfeited its safe haven status. This is significant because numerous Canadian institutional investors who did not hedge the currency risk on their U.S. investments are now compelled to increase their hedge ratios,” remarked Shaheryar Baig.
The forecast for the U.S. economy is also deteriorating. Emerging from the pandemic, it expanded more rapidly than other economies, but that trend has reversed. Projections for U.S. growth have diminished and are now aligned with those of other advanced economies, he noted.
The Organisation for Economic Co-operation and Development cautioned last week that Trump’s tariff conflict will hinder global growth in 2025, and it assigned the United States the most significant downgrade among G7 nations. The OECD predicts its growth will decelerate sharply from 2.8 percent in 2024 to 1.6 percent this year, and 1.5 percent next.
Trump’s strategies aimed at increasing the income share of American workers are causing concern among investors, according to Shaheryar Baig. Instructing Walmart Inc. to absorb the tariffs and threatening Apple Inc. with duties on overseas products does not contribute to enhancing the profits that investors seek.
“To numerous investors, American capitalism now bears a resemblance to Chinese ‘common prosperity,'” he remarked.
Desjardins acknowledges that its forecast carries certain risks. The United States managed to avoid a widely anticipated recession in 2023, and its economy may surprise once more. The carry trade in the U.S. dollar, which offers the highest deposit yields in the G7, could also see a revival, he noted.
The disadvantage of a robust Canadian dollar against the U.S. dollar is that it renders exports more costly, which is a burden on Canada’s already delicate economy.
Desjardins is of the opinion that this situation will compel the Bank of Canada to reduce its interest rate by an additional 75 basis points to 2 percent this year.
Canada’s manufacturing sector has been adversely affected by tariffs, but recent data indicates that the services sector, which constitutes a significantly larger portion of the economy, is also experiencing difficulties.
S&P Global’s Services PMI for May reveals that this sector is not only contracting but is also the weakest among all 14 countries analyzed, according to economists at the National Bank of Canada.
Earlier last week, S&P Global’s manufacturing PMI ranked Canada as the lowest among 30 countries.
“That places Canada at the bottom in both manufacturing and services, making it a clear outlier among this group of key peers,” stated National.