Money Is the Canadian Dollar Heading to Parity With U.S. Currency Again?

20:12  12 september  2017
20:12  12 september  2017 Source:   The Motley Fool

Soaring Canadian dollar set to pull back in coming months: Reuters poll

  Soaring Canadian dollar set to pull back in coming months: Reuters poll By Fergal Smith

Interest rate parity refers to the fundamental equation that governs the relationship between interest rates and currency exchange rates. Of course, at the beginning of 2002, with the Canadian dollar heading for a record low against the U . S . dollar , some U . S . investors may have felt the need to

• Firm commodity prices, Canada ’s relatively strong fiscal position and widening interest rate spreads should support a Canadian dollar above parity with the U . S . over the medium term.

  Is the Canadian Dollar Heading to Parity With U.S. Currency Again? © Provided by Fool

After seeing a sudden jump in the value of Canadian dollar against its U.S. counterpart, many investors might be thinking about how far this move can go, and if the loonie can trade at par with the U.S. dollar again.

Let’s find out what’s driving the Canadian dollar higher and if those factors which propelled the currency to a 24-month high can support its surge to parity this time.

One of the biggest factors that makes a currency stronger is the interest rate differential. Investors move their funds in jurisdictions where they’re able to get the best returns.

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The Canadian dollar took flight again Wednesday, passing 97 cents ( U . S .), amid higher oil prices and as global investors offloaded the U . S . currency . Many economists said they expect the dollar to reach parity by the end of the year: What's been pushing the dollar so high?

The value of the Canadian dollar was fixed in terms of gold and valued at par with the U . S . currency . 2007: The loonie takes flight again . On May 31, it topped 94 cents ( U . S .) - the highest level in 30 years. Later that year it hit parity in September.

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That’s the main reason fueling gains in the Canadian dollar for the past two months. The Bank of Canada, which has remained on the sidelines for almost seven years, started raising interest rates in July after a strong economic performance.

Surprising many analysts, the Bank of Canada acted again on Sept. 6 and raised its benchmark interest rate to 1%. These moves and the central bank’s bullish tone on the economy sent Canadian bond yields soaring.

For the first time since May 2015, the yield on the Canadian two-year government bond rose more than its U.S. counterpart, suggesting that investors are expecting the Bank of Canada will hike interest rates again.

Bank of Canada watching impact of higher rates, stronger C$: Lane

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It drifted to parity with the US dollar by 1972. On April 24, 1974 the Canadian dollar reached .0443 (US). This was the high point for the dollar from when it entered its most recent oat period and would not trade at these levels again for another 30 years.

The proposal was studied by a parliamen-tary select committee on banking and currency , headed by Francis Hincks, who strongly favoured the Once again , the Canadian dollar traded at par with its U . S . counterpart. By 1972, the Canadian dollar had traded through parity with its U . S . counterpart.

How strong can the Canadian dollar get?

Let’s get back to that scenario that could make the Canadian dollar even against the U.S. dollar — a scenario we last saw in early 2013.

In order for the loonie to trade at parity, we need a strong rally in commodities, which make up a major part of Canadian exports. The move in the Canadian dollar has a strong correlation with oil prices.

When the Canadian dollar was at par in early 2013, for example, crude oil was trading close to $100 a barrel; the current price is $49 a barrel.

So, if the Canadian dollar isn’t headed to parity, then how far will it go? In the short run, it’s all about the expectations regarding Canadian interest rates. If the central bank pauses here and inflation remains subdued, I think we’re not going to see too much appreciation beyond 82 to 83 cents a U.S. dollar.

For the central bank, an interest rate move that’s too aggressive and too quick carries some risk at a time when Canadians are carrying a record level of debt.

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In days gone by, one required neither an advanced degree in economics nor a crystal ball to predict the performance of the Canadian currency . Davis expects the Canadian dollar to start climbing toward parity again . “From a trend perspective, I certainly think that’ s where we’re headed ,” he says.

The Canadian loonie is again flying near parity with the U . S . greenback -- but this time no one is surprised and most expect the currency to remain aloft for years.

Investor takeaway

The rising loonie presents some opportunities for investors looking to take advantage of this situation and re-adjust their portfolios.

Retailers and airline stocks, such as Dollarama Inc.(TSX:DOL), Canadian Tire Corporation Limited(TSX:CTC.A), and Air Canada (TSX:AC)(TSX:AC.B), are likely to benefit from a strong currency as their imports become cheaper and as Canadian travelers find their overseas trips more affordable.

Canadian exporters, such as West Fraser Timber Co. Ltd. (TSX:WFT), will find this sudden surge in the value of currency tough to stomach as rising currency eats into their margins.

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Bank of Canada rate hikes done for 2017; faster pace seen in 2018: Reuters poll .
By Leah Schnurr and Anu Bararia define("homepageFinanceIndices", ["c.deferred"], function () { var quotesInArticleFormCode = "PRMQAP"; var config = {}; config.indexdetailsurl = "/en-ca/money/indexdetails"; config.stockdetailsurl = "/en-ca/money/stockdetails"; config.funddetailsurl = "/en-ca/money/funddetails"; config.etfdetailsurl = "/en-ca/money/etfdetails"; config.recentquotesurl = "/en-ca/money/getrecentquotes"; config.commoditydetailsurl = "/en-ca/money/markets/commoditydetails"; config.currencyConverterUrl = "/en-ca/money/currencyconverter"; config.

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