Last month, I made the argument that the loonie was set to head lower from here.
The main reasons for my argument were specifically over-reliance on exports to sustain growth, as well as high household debt levels.
That said, the loonie has seen significant upside against the dollar this month, up to 0.7521 at the time of writing:
What is the reason for the recent gain in the loonie, and is it temporary?
Primarily, we saw the loonie shoot up earlier this month as a result of tariff reliefs on Mexican goods by the United States. This is significant for Canada as it increases the chance of a potential new trade deal with Mexico and the United States.
In terms of the Canadian economy itself, exports are fueling growth at this point in time, with the trade deficit having reached a six-month low. That said, there has been increasing concern over a potential slowing of Canadian exports to China, due to the straining of diplomatic relations between the two countries. Canola exports to China have fallen by 14.7%, while the increase in wheat exports of 21.7% was largely driven by China.
In this regard, a risk for Canada’s economy at this point is a worsening of tensions with China, at which point, we would see the loonie drop as a result of reduced export demand.
However, unemployment rates in May have fallen to a new four-decade low, with 27,700 net new jobs having been added in the month. However, with the size of the labour force itself having decreased by 50,000, this moderated the overall gain in employment. Should we see continued rises in employment over the long term, then this could allow Canada to diversify away from export-led growth, and as a result, the economy would not be as dependent on a weak loonie to sustain exports.
The fact that the spike in the loonie has been driven by Mexican tariff reliefs underlies the continued dependency of the Canadian economy on trade, and in this regard, I do not see sustained strength for the loonie in the near future.
Moreover, it is increasingly anticipated that the Bank of Canada will be set to cut rates once again in 2020 due to risks posed by trade tensions as well as lower oil prices. From this standpoint, gains in the loonie look particularly unlikely.
While the employment numbers for the Canadian economy look promising, trade concerns will continue to weigh on the loonie. I anticipate that the CAD/USD could reach a prior low of 0.74 once again.
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