Loonie drop is a reflection of economy

“Derek, why is the Canadian Dollar so much less than the US Dollar?” Since we typically use Canadian dollars on a day-to-day basis the change in value compared to other currencies should matter all that much. However, with that in mind many of us travel, own property outside of Canada, run a company, or partake in online shopping and the value of our dollar is important. Compared to this time last year, our loonie has declined roughly 16% when compared to the US greenback. So what’s causing this?

“Derek, why is the Canadian Dollar so much less than the US Dollar?”

Since we typically use Canadian dollars on a day-to-day basis the change in value compared to other currencies should not matter all that much. However, with that in mind many of us travel, own property outside of Canada, run a company, or partake in online shopping and the value of our dollar is important. Compared to this time last year, our loonie has declined roughly 16% when compared to the US greenback. So what’s causing this?

To understand the movement of our loonie we need to understand that in very simplistic terms, the value of a country’s currency is a gauge of the health of the economy. Said another way, our Canadian dollar is lower because our economy isn’t performing near as well as the US economy.

It’s also important to understand that central banks have the ability to change interest rates to guide their respective economy accordingly. In Canada, our central bank is referred to as the Bank of Canada. As our economy begins to cool, the Bank of Canada may decrease interest rates to encourage spending and business development. The intent here is ultimately to produce jobs which in turn should boost the economy.

So thinking back to this time last year, the Canadian economy was doing well and the price of oil was hovering around $100. Compared to today, oil is closer to $50 and there have been a notable slow-down in the energy sector. The decline in the price of oil has a direct impact to our economy.

The Bank of Canada with this information in mind decided to reduce interest rates. This rate cut occurred in January which brought our already faltering loonie from around 84 cents to 80 cents in a matter of days. In very basic terms this signalled that the Bank of Canada was worried about our economy which pushed the value of our currency lower.

All of this has brought our dollar trading at less than 80 cents. On one side of the coin, this is good for companies that sell their goods in US dollars. Their production and labour costs are still in Canadian dollars, but their product sells for US, thus giving them a 20 cent per dollar advantage that they didn’t have the year prior. That said companies which import goods in US dollars to sell to Canadian consumers have either had to increase prices, or decrease profits, or both.

Furthermore, and where it is noticeable for many of us, that trip to Disneyland is now 16% more expensive as are all those goods we buy online and ship north to Canada. To a certain extent, this is also why the price at the pump is higher too. Generally speaking Canada buys all its fuel in US dollars, which in turn means lofty rates at the gas station. Looking ahead, I don’t expect this trend to change. In fact, I wouldn’t be surprised to see the Canadian dollar decline to $0.75 or lower within the next 12-months. The US economy will likely continue to strengthen while our economy works through the issues with the price of oil among other challenges. In fact, another rate decrease may be right around the corner which won’t help the loonie.

With this knowledge in hand, if you have a trip upcoming you may consider buying US dollars sooner than later. Otherwise you could postpone that trip south of the border and travel across Canada instead; there are many wonderful destinations within our borders and currency won’t be an issue.

From an investment standpoint, it may be prudent to hold more US dollars, although this would require a discussion in terms of your risk tolerance and investment goals.

While it’s difficult to predict the movement in currency a weakening economy tends to create downward pressure. With all this in mind, none of us have any control over how currency will move and as such the best we can do is plan accordingly.

Happy investing,

Wealth Watch is written by Derek Fuchs, a wealth advisor with ScotiaMcLeod in Red Deer. It is provided for informational purposes only and any opinions contained in it are his own. Readers are urged to consult a wealth advisor for help with their personal investment circumstances. Fuchs can be contacted at derek.fuchs@scotiamcleod.com.

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