As of the last week of January 2020, the Canadian dollar (CAD) has weakened against the US dollar (USD) for seven straight weeks. By the evening on January 27, one of Canada’s dollar purchased only $.76 in the US. While speculation that the Bank of Canada would increase interest rates eased some of the downward pressure when it declined to do so on January 22, the outbreak of the coronavirus in China has caused oil prices to decrease across the world. Given Canada’s large oil industry, the CAD fell along with the price of crude oil. More generally, concerns over US President Donald Trump’s protectionist inclinations have proved to be a damper on Canada’s dollar for the past few years.
If this sounds confusing, you are not alone as foreign exchange is no simple matter. Factors influencing the exchange rate with the US range from commodity prices to political developments. Let’s now look at some of the reasons why the exchange rate fluctuates.
Both the USD and CAD are managed by central banks. North of the border it is the Bank of Canada that manages things, while the southern side is managed by the US Federal Reserve. Both central banks manage the pace of the economy in each country by adjusting the interest rate at which commercial banks lend money to each other, which in turn affects interest rates nationwide. When interest rates are higher, a currency’s value generally rises. When it falls, it generally decreases. Central banks try to find a balancing act in order to stimulate the economy by not raising rates too high while also keeping inflation in check by not keeping them too low. The result is that rate changes in Washington can affect the exchange rate in Ottawa and vice-versa. The Canadian dollar reached its lowest point of the past 10 years in January 2016, for instance, at a time when it was widely anticipated that the US Federal Reserve was going to increase the interest rate.
Confidence in political systems can also affect exchange rates for better or worse. If investors are apprehensive about economic policies in either the US or Canada, we can expect the value of the currency to fall. US currency reached its weakest point against Canada in the past decade, for instance, amidst unprecedented hesitation among Republicans in the US Congress to raise the debt ceiling, which was necessary for the US Federal Reserve to continue servicing the bonds it had previously issued. Had the US not raised the debt ceiling, the US would have begun defaulting on its loans. That possibility sent investors into a panic and the dollar into a tailspin.
As the Canadian economy is disproportionately dependent on the oil industry relative to the US, spikes in the price per barrel of crude oil cause its dollar to rise while drops cause its money to go down. In both 2014 and 2016, for instance, Canada’s dollar went down against the dollar as oil prices plunged worldwide.
The US dollar has remained relatively close to the Canadian dollar in the past decade on the currency exchange, reaching its peak value in 2016 at $1.458 and its lowest in 2011 at $.944. But while this volatility is nothing compared to the chaos of the Russian ruble or the Turkish lira in recent years, it is unpredictable enough, in the long run, to be interesting to currency speculators. Going forward, the future of the USD-CAD exchange rate is dependent on what happens next both in Washington, Ottawa and much further afield in financial centers from Hong Kong to London.
The good news, however, is that a lower-valued currency is not all bad. While vacationing in New York may be a bit more expensive for Canadians when its dollar is down, companies are more likely to invest in Canada as it becomes cheaper to do business. Rather than always wishing for a strong currency, a good balance is key to long-term economic success.