Recessions or prolonged periods of time in which a country’s financial system declines, are a natural part of the economy. Right now, we are over a decade into a bull market (a financial market condition of a securities group in which prices are either rising or are expected to rise), the longest in the history of the financial market. That’s why many people fear that a Canadian recession is coming and a US one is looming. In reality, we probably won’t know that we are in a recession until we actually are in one.
While you don’t need to panic, you should definitely be prepared. The first step is being knowledgeable and aware of some key indicators beforehand.
What Are the Indicators of a Recession?
The truth is that there’s no proven way of knowing that the economy is about to slide into recession. However, there are some indicators that might be worth monitoring.
- The unemployment rate is often considered an essential barometer of a coming recession. Once it rises to 0.50 percentage points (or 50 basis points) from its low, it can mean that the economy is heading for a recession.
- Short-term interest rates being higher than long-term ones leads to a strange phenomenon called an inverted yield curve, which can be deemed a recession warning.
- Consumer confidence is another sign: when consumers are worried, their confidence and spending decreases. When consumers are restricting their spending can also be an indicator that a recession is on the horizon.
The government, through the Minister of Finance or organizations like the Bank of Canada, is responsible for letting the nation know when the country is both in and out of recession.
Does the recession affect currency exchange?
The short answer to this question is yes. To accurately explain our response, let’s take a look at what happened to the currency exchange rates during the previous downturn period.
Back in 2008, a global financial crisis, known as the Great Recession, affected Canada for seven months and it lasted one and a half years in the US. Throughout that time, USD’s foreign currency exchange rate rose unexpectedly. As a consequence, treasuries fell to (then) record lows. In December 2008, the rate was 2.25, which was the lowest, compared to everything recorded by then. Other recent low scores were recorded in May 2003 (3.37), but they were still higher than the 2008 numbers.
Some possible reasons for a US dollar’s unforeseen exchange rate rise in an economic decline are:
- A USD shortage aggravated by import-export businesses’ and investors’ reaction to the recession;
- Investors fleeing to alleged “safe haven” currencies;
- “Overhedging” – a strategy that numerous banks from all over the world found on their balance sheet the value of certain risky USD-denominated assets instantly fell as the international downturn took place;
- Long-established carry trades being reversed.
During a recession, as banks pull funds from supposed high-risk countries, foreign currency exchange rates worldwide become progressively volatile, which makes hedging for global trade and making FX funding very difficult. Consequently, international trade can greatly contract, which might cause losses for many global businesses.
All of this suggests that foreign exchange rates are linked to recession.
How will the Canadian dollar and the USD exchange rates behave in a recession?
When countries like Canada and the US go into recession, inflation is likely to fall. Lower inflation helps the nation become more competitive, which could increase demand for the currency causing it to rise.
Let’s focus on the US dollar for a bit. Since the USD is one of the most dominant currencies, the US benefits of the privilege of paying low-interest rates on safe dollar-denominated assets. When the international economic risk is high, investors tend to switch to dollar-denominated assets in order to avoid uncertainty. This, as we’ve already mentioned above, can lead the USD to appreciate.
What does it mean for currency exchange?
Simply put, in case of a recession, the US dollar can rise again, which means that the exchange rate won’t be a favorable one for Canadians who need to buy USD.
Should you buy US dollars now?
Taking into account that the currency skyrocketed throughout the previous financial crisis and chances are this will happen again, it would be wise to buy US dollars now rather than waiting, especially if you plan on exchanging currency in the near future.
If you often use USD or you need it for travel, college tuition, buying real estate, sending money to family, or moving to another country, it’s recommended to buy USD before an unexpected recession. Generally speaking, the higher USD amount you exchange, the higher will be the fees you’ll pay. So why not use a service like KnightsbridgeFX which can provide a lower rate, thus you’ll spend less on exchange fees.
KnightsbridgeFX, a Canadian currency exchange company that focuses on helping its customers save money, offering bank-beating exchange rates, which makes it a great option for buying USD. KBFX calls the banks every morning to ensure that their exchange rates are better. Transactions can be done same-day through online bill payment or through the client’s existing bank. An experienced and helpful team is happy to assist every customer exchange currency in a safe, easy, and quick way.