Game over for the loonie?

Although the loonie bounced back this week, it still trades at a low level relative to where it’s been for the past three years. Is the most recent decline a sign that the Canadian dollar is at the beginning of a longer-term drop against its U.S. counterpart?

This scenario is quite possible. Consider what’s influencing currency markets at present. First, many countries around the world are trying to weaken their currency to make exports cheaper and boost economic growth.

This saw the U.S. trade-weighted dollar strengthen to levels not seen since 2010 and created a scenario where the U.S. dollar was the big winner in the currency market, while every other currency (including the loonie) came under selling pressure.

Read: Loonie back to parity by late 2014: CIBC

Considering what’s currently going on in Europe and China from an economic growth perspective, we expect fund flows will continue moving into U.S. dollars in the coming quarters.

Second, whether justified or not, Ben Bernanke’s back-and-forth discussion about “tapering” bond purchases has left investors with the impression that U.S. monetary policy may be set to turn. Such a scenario, in conjunction with higher bond yields, has strengthened the U.S. dollar even further.

So where does this leave the Canadian dollar? First, it’s fair to say the loonie has been more a victim of U.S. dollar strength than Canadian weakness. However, a decline in various commodity prices, thanks to a slowdown in China and the recent plunge in the bullion market, have only exacerbated the decline of the loonie. It’s only saving grace from a commodity perspective is that oil prices have held up well due to geopolitical events in the Middle East, but we expect oil prices to come under pressure from a fundamental supply/demand perspective.

What’s clear is that the world no longer views the U.S. dollar as a relatively weak currency, as it’s now the currency of choice for traders who need safety and stability. We don’t expect this view to change in the near term, so we would not be surprised to see the Canadian dollar remain in the mid-90 cent range, if not weaken further going forward.

It will be very difficult for the loonie to retest parity without a resurgence in commodity markets or an unexpected decline in U.S. economic growth.

TRADING WEEK AHEAD

While corporate news may have been quiet over the past month or so, it’s about to get a lot noisier next week as U.S. earnings season kicks into full gear.

While Shoppers Drug Mart is the only larger-cap company to report in Canada on Thursday, we’ll see many large-cap names report in the U.S., including a third of the Dow Jones Industrial average.

Most of the world’s major central banks have held policy meetings of late, and the Bank of Canada will be the next to make an interest rate announcement. There will be no shock when Stephen Poloz announces on Wednesday that rates will remain unchanged. This bias is likely to continue as the new governor settles in over the next six-to-twelve months.

Read: Fed faced with upbeat employment forecasts

The next influential central bank announcement will be from Ben Bernanke and the Federal Reserve at the end of the month. In Canada, focus will be squarely on inflation at the end of the week; however, economists believe that core inflation will remain low and thus central bankers will continue sitting on their hands.

As events in the Middle East unfold it would not be surprising to see oil prices remain above US$100 barrel for the time being, but any progressive developments in either Egypt or Syria could see oil speculators move off of their positions. While some gold bugs are sniffing around bullion for a quick trade, we don’t expect much action in the gold markets next week and the Canadian dollar should continue to hover around the mid-90 cent range.

Read: Gold bugs are bullish

Gareth Watson is the Vice President, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @Gareth_RGMP