So what’s up with the Canadian dollar?

While many thought the currency would strengthen in 2023, the loonie has slid to depths not seen since the height of the pandemic. (This morning it was trading near a 6-month low of 72.43 US cents)

A big part of this mystery is that the drivers of the currency have changed. When a hawkish Bank of Canada was raising interest rates it supported the loonie, but now that the slowing economy has reduced the risk of more hikes, new drivers are taking over.

“The loonie has never met a crisis it didn’t want to join,” writes BMO chief economist Douglas Porter in a recent note.

Geopolitical turmoil is a big one. The outbreak of war in the Middle East has dampened global risk appetite, hitting currencies like Canada’s hard.

If that situation deteriorates, the loonie could drop as low as 71.4 US cents, say analysts with Monex Canada.

Then there is the global bond meltdown. Porter says a side effect of the rise in long-term Treasury yields is a rebound in the U.S. dollar, “a secondary pain trade which has of course skewered almost all other currencies.”

Another weight on the loonie is the rather surprising gap between the Canadian and American economies. Porter said normally there isn’t that much difference between the GDP growth rates of the two countries because of Canada’s economic dependence on its southern neighbour.

Yet in the third quarter U.S. GDP hit an eye-popping 4.9 per cent annual rate, while Canada, according to early estimates, dipped slightly into contraction.

“As Canada stagnates and faces a looming recession, the U.S. economy looks set to strengthen further from an already-solid pace of growth,” said Monex Canada FX market analysts Jay Zhao-Murray and Simon Harvey.

In the 30 years before COVID there were only two quarters in which U.S. growth exceeded Canada’s by so wide a margin, Porter said. One was during SARS in 2003 and the other during the oil collapse of 2015, both bad times for this country.

While Canada was dealing with a B.C. ports strike and historic wildfires in the third quarter this year, “those can’t come close to explaining the wide growth differential,” he said.

Even more disturbing is that Canada’s population growth has surged much faster, he said. Per capita, U.S. GDP has grown more than 2 per cent while Canada’s has declined by more than 2 per cent, “a staggering divergence.”

So why the gap? Porter said indebted Canadian households, under more strain from higher borrowing costs, are cutting back on spending, while Americans continue to consume. The interest-rate-sensitive housing sector also makes up a bigger portion of Canada’s GDP.

American fiscal policy is also boosting the economy south of the border. The U.S. budget deficit for the year has grown to $1.7 trillion, more than 6 per cent of GDP, while Ottawa’s deficit came in below forecast at $35.3 billion, or 1.3 per cent of GDP.

“The fiscal fuel was a big reason why the consensus (and we) completely underestimated U.S. growth this year,” said Porter.

This “fiscal largesse” has forced the Federal Reserve to hike interest rates higher than expected and boosted the U.S. economy and dollar, he said.

But the list of the loonie’s challenges doesn’t stop there.

Monex analysts expect Canada’s slowing economy will force the Bank of Canada to cut interest rates earlier and more aggressively than the Fed. The difference between the rates will put more even more pressure on the Canadian dollar, which could push it down to 71 cents in early 2024.

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There’s been a lot of talk lately about how the economy has yet to feel the full brunt of the rise in interest rates seen over the past 19 months.

Since the impact of a rate increase today won’t be fully incorporated into the economy until 12 to 18 months down the road, we are just now feeling the effects of last summer’s hikes, says BMO senior economist Robert Kavcic, whose chart simulates how the tightening cycle will work through the system.

Though Kavcic cautions that the estimates are variable, the chart shows that between now and early 2024 the full impact of rate hikes will be absorbed.

“The takeaway is a tough one for the Canadian economy,” Kavcic said. “Growth is clearly struggling even with more tightening still to digest.”

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Most of us want to know if we’ll be financially OK for the rest of our lives, which is why it’s so tempting to use those free online tools to get a quick answer. But wealth adviser Ted Rechtshaffen says those tools just scratch the surface. Here’s how to really find out

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Today’s Posthaste was written by Pamela Heaven, @pamheaven, with additional reporting from The Canadian Press, Thomson Reuters and Bloomberg.

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