A Long History of the Loonie

By David Dittman • August 24, 2012 • Canadian Edge Weekly

The Canadian dollar is on track to close August above parity against the US dollar on a monthly basis for the first time in 2012 since April, helped along today by hopes that European Central Bank President Mario Draghi will announce new plans for bond purchases following the ECB’s next interest rate meeting on Sept. 6.

In the last 40 years the loonie has closed above parity with the greenback a total of 52 times. Between August 1972 and October 1976 it did so 35 times. But then it hit a bearish patch, not reaching USD1.00 on a monthly closing basis again until September 2007. It’s done so another 16 times since.

Source: Bloomberg

As of this writing the loonie was at USD1.0086, just off its intraday high and well up from the 2012 closing low of USD0.9606 set Jun. 1. This surge has been driven by expectations of renewed central bank efforts around the world to prop up sagging economies with monetary stimulus as well as rising oil prices.

As I noted last week, however, there’s a growing perception among market participants the world over that Canada and its currency represent something more than simply crude oil. Investors continue to buy Canadian government bonds, and central banks continue to diversify foreign holdings away from the euro and the US dollar in favor of currencies perceived to have better underlying fundamentals, such as the Canadian dollar and the Australian dollar.

The loonie reached an all-time low of USD0.6179 on Jan. 21, 2002, as the US dollar rose against all major currencies. Back then huge amounts of private capital flowed into the US because of what was then a robust and growing economy.

A decline in commodity prices in 2001, caused by an abrupt slowdown of the global economy, led by the US, also undermined the Canadian currency, and global markets were unsettled by the Sept. 11, 2001, terrorist attacks in the US.

Amid the ensuing economic and geopolitical uncertainty central banks around the world lowered interest rates to support demand and provide liquidity to markets. The Bank of Canada reduced short-term interest rates by 375 basis points through 2001 and early 2002.

The loonie stabilized during 2002 and then began to recover along with the global economy. It appreciated sharply against the buck through 2003 and 2004, peaking at over USD0.85 in November 2004, a level it hadn’t seen more than a decade. From its January 2002 low to its 2004 peak the Canadian dollar appreciated 38 percent.

This rise was supported by robust global growth, led by the US and emerging Asian markets, China in particular. Canada’s commodities, crude oil in particular, saw significant price increases. At the same time, however, the loonie’s rapid ascent was in part traceable to growing investor concern about widening US deficits.

Rising US interest rates in early 2005 stemmed the loonie’s rise somewhat, but by that summer rising energy prices once again put the wind beneath its wings. Oil, as measured by the generic-front month futures contract traded on the New York Mercantile Exchange, peaked just shy of USD70 in late August 2005 and closed the year at USD61.04.

During 2006 the first signs of a crackup in the US housing market began to appear, and economic growth and job growth both fell from the high levels of previous years. This slowdown in the world’s largest economy was reflected in both commodities prices–oil peaked at USD77 per barrel in mid-July but closed 2006 at USD61.05, while the loonie slid from a late May high of USD0.9102 to USD0.8578.

Meanwhile, the federal government continued to run large deficits.

Through 2007, even as the demise of the US housing boom and corresponding squeeze of the US consumer grew more obvious, the price of crude oil pushed ever higher. Even though the US dollar took a dive, and investment bank after investment bank announced multi-billion dollar losses on subprime mortgages, the economy grew nicely, at least until the fourth quarter.

Reflecting the deteriorating situation south of the border but also the continuing rise of commodity prices, on Nov. 6, 2007, the Canadian dollar established its all-time closing high of USD1.0865.

The loonie quickly came back to Earth, descending below parity by Dec. 4, 2007. Oil didn’t peak until Jul. 3, 2008, at USD145.29 per barrel. Although the September 2008 bankruptcy filing by Lehman Brothers is widely considered the beginning point of the late 2000s global downturn, the National Bureau of Economic Research, the official arbiter of such things, has pegged the start of the US part of the recession in December 2007.

The violent economic contraction in the fourth quarter of 2008, as Lehman’s demise made this the Great Recession, caused a dramatic drop in demand and the price of oil fell below USD35 a barrel by the end of the year.

Source: Bloomberg

At this point central banks around the world, including the Bank of Canada and the US Federal Reserve, started cutting rates in dramatic but coordinated fashion. Fiscal authorities, in the Great White North and south of the border as well, enacted large stimulus packages intended to support demand. March 2009 is widely regarded as a turning point, when markets bottomed and major economies started showing signs of stabilization and, in some quarters, growth.

The loonie hit a cycle low of USD0.7685 in early March 2009, pushed there as investors sought what was still perceived to the safe haven of US dollar-denominated assets as well as the steep slide in the price of crude. It bounced back to USD0.9506 by the end of 2009.

The Canadian dollar closed 2010 above parity with the US dollar, strong on a relative basis because the economy supporting it boasted stronger underlying fundamentals and the government had a decade’s worth of balanced budgets as well as a record of reducing deficits behind it before it enacted fiscal stimulus efforts.

Canada’s pledge to return to budget balance has some credibility. The country was also better able to withstand the pressures of the Great Recession because its banks eschewed widespread weakening of credit standards in the hopes of stimulating home-buying in the years leading into the crisis. Though unemployment spiked, it’s since returned to manageable levels, and though Canadians do have high levels of debt they’re also experiencing rising incomes.

The effects of the Great Recession are still with us, however, and it’s becoming apparent that oil, which is still the world’s most important energy resource, has found a new and higher normal price range. This factor contributes to the strength of the loonie, before and since the worst of the late 2000s meltdown.

But there are other reasons for the Canadian dollar’s return to parity. And there’s compelling evidence the flight of the loonie will continue well into the current decade.

One great way to gain exposure to this bull market is to buy and hold dividend-paying Canadian equities.

The Roundup

Here’s where to find second-quarter earnings analysis and outlook for all Canadian Edge Portfolio Holdings. The only company not yet reporting is Student Transportation Inc (TSX: STB, NSDQ: STB), which is on a different reporting schedule. The company will release its fiscal 2012 fourth-quarter and full-year (ended Jun. 30) results in late September.

Conservative Holdings

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