Worst over for Canadian dollar, say economists

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The Canadian dollar has had a tough year so far, but the worst could be over, according to economists.

Desjardins Group is scrapping its forecast that the loonie would sink to 67.56 cents U.S. this year and now predicts it will hold between 70.92 and 68.96 cents U.S. over the next three months.

Why the change? This year there has been a shift and suddenly the Federal Reserve is “out-doving” the Bank of Canada.

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Recession risks are rising in the United States and the Fed on March 19 signalled that growth was becoming more of a concern, even referring to the impact of tariffs on inflation as “transitory.” 

Inflation, on the other hand, popped up frequently in remarks at the Bank of Canada’s meeting March 12.

“The Bank of Canada has turned cautious on the pace of rate cuts, while the Fed waits for hard data. Yield spreads may narrow, especially if the U.S. labour market cracks,” said Desjardins chief economist Jimmy Jean and foreign exchange strategist Mirza Shaheryar Baig.

Narrowing the spread between the interest rates of two central banks would bolster the Canadian dollar.

Meanwhile, the appeal of the U.S. dollar as a safe-haven has been rocked by the policy upheaval of Donald Trump’s new U.S. administration. 

“With a made-in-America recession lurking, the U.S. dollar is unlikely to hedge risky assets as it did in the past,” said Jean and Shaheryar Baig.

While the Canadian dollar has held fairly steady against the greenback, it has “depreciated significantly” against other currencies, which should help Canadian exporters find new markets outside North America, they said.

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The loonie could appreciate even further if economic reforms to boost productivity now being proposed in the federal election bear fruit.

“Bringing more of Canada’s vast resources to international markets would also increase demand for the Canadian dollar,” said Desjardins.

Bank of America’s forecast for the Canadian dollar is even higher at 71.42 cents U.S., mainly because of their “sanguine view” on tariffs.

They expect the March equity flight from risk to reverse, oil to average US$66 and markets to reprice the Bank of Canada terminal rate higher as tariff tensions de-escalate.

“Tariffs do not need to fully unwind this year for USD/CAD to fall to our forecast,” said economist Carlos Capistran.

“A gradual shift toward constructive communication between U.S. and Canada on trade terms, making February 1 the peak tariffs panic moment for the year, should still drive USD/CAD meaningfully lower, in our view.”

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The budgets of seven of Canada’s 10 provinces are out and according to an estimate by National Bank of Canada the combined deficit adds up to $32 billion, double the forecasts for this fiscal year made a year ago.

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“The budgetary tone, unsurprisingly, has shifted massively relative to prior guidance, tariff risks front and centre,” said National economist Warren Lovely.

The provinces are now focused on downside risks with tariff, slower growth and lower oil price scenarios hinting that the red ink could grow to about $40 billion this fiscal year, which would be a record shortfall for the group, he said.

Ontario’s budget will have to wait until after legislature resumes April 14, as will the federal budget which is on hold until after the April 28 election.

• Today’s Data: U.S. construction spending, ISM manufacturing
• Earnings: Novagold Resources

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Today’s Posthaste was written by Pamela Heaven, with additional reporting from Financial Post staff, The Canadian Press and Bloomberg.

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