Posthaste: Why economists are cutting their forecasts for the Canadian dollar

The Canadian dollar is losing ground, prompting some economists to cut their forecasts for the currency “substantially.”

Desjardins Group had predicted the loonie would hit 74 U.S. cents by the end of this year, but has now cut that forecast by three cents to 71.

“Our year-end USDCAD forecast of 1.35 [74 U.S. cents] now appears a long shot,” said Desjardins chief economist Jimmy Jean and foreign exchange strategist Mirza Shaheryar Baig

in a recent report.  “We have changed our forecasts and now expect the loonie to remain soft in the next two quarters before gradually strengthening towards the end of next year.”

After hitting 74 U.S. cents in June, the Canadian dollar has been on a downward track not just against the U.S. dollar, but other major currencies as well.

“This wasn’t just a U.S. dollar story,” said the strategists. Canada’s currency has sunk 6 per cent against the Mexican peso, 5 per cent against the euro and 3 per cent to the renminbi.

The Bank of Canada’s CEER Index, a weighted average of bilateral exchange rates for the Canadian dollar against the currencies of major trading partners, is near a nine-year low, they said.

Desjardins suspects two key drivers are clipping the loonie’s wings. Pension fund hedging flows have abated and the

Canadian economy is lagging the United States. Canada’s economy didn’t grow in the first half of the year, and Desjardins expects growth in the third quarter at less than 1 per cent. Businesses remain cautious under the threat of

U.S. tariffs and households are under strain as mortgages renew at higher rates. The rapid deceleration in population growth has also weighed.

While fiscal stimulus is expected in the upcoming federal budget , its benefits won’t show up until well into 2026, said the strategists.

Down south it’s a very different picture. Sturdy consumer demand and business investment drove growth higher in the first half of the year, especially in high-tech sectors, and economists are now “significantly” upgrading their forecasts. The

Federal Reserve Bank of Atlanta’s GDPNow currently puts growth for the third quarter at 3.9 per cent.

There are risks to the U.S. outlook. Trade tensions with China could escalate, the government shutdown could drag on to the point that it damages the economy and high-flying tech stocks could suffer a correction.

“The U.S. dollar has stabilized for now but remains vulnerable should any of these risks materialize,” said the strategists.

However, another of the loonie’s driver, pension fund hedging, has taken a back seat since the summer. Desjardins said Canadian pension funds significantly raised their forex hedge ratios in the second quarter, boosting the Canadian dollar, but now they appear to be sitting on the sidelines.

With that wave over, rate differentials — the gap between the rates of the Bank of Canada and U.S.

Federal Reserve — is reasserting its sway over the Canadian dollar. Both Canada’s central bank and the Fed decide on interest rates tomorrow, and both are expected to cut, putting their rates at 2.25 per cent and 3.75 to 4 per cent, respectively.

But Desjardins thinks that gap could widen further, putting more pressure on the loonie, if the Bank of Canada cuts its rate to 2 per cent faster than markets expect, as they predict.

The Canadian dollar was trading at 71.40 U.S. cents this morning.

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Construction costs in Canada have shot up 67.7 per cent since the end of 2019, the fastest pace among advanced nations.

All major economies suffered a spike in building costs amid the global supply shock and high commodity prices brought on by the COVID-19 pandemic, but in Canada there were regional factors at work as well, said Desjardins Group economists. A shortage of skilled labour, regulatory red tape and intense real estate speculation, especially in Vancouver and Toronto, all helped push up costs.

Canada, however, is not the most expensive place to build homes. That goes to New York, which tops the World Population Review’s list at US$5,723 per square metre. Vancouver ranks 15th at a cost of US$3,063 per square metre.

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McLister on mortgages

Read on Want to learn more about mortgages? Mortgage strategist Robert McLister’s

Financial Post column can help navigate the complex sector, from the latest trends to financing opportunities you won’t want to miss. Plus check his

Financial Post on YouTube

mortgage rate page for Canada’s lowest national mortgage rates, updated daily. Visit the Financial Post’s YouTube channel for interviews with Canada’s leading experts in business, economics, housing, the energy sector and more.

Today’s Posthaste was written by Pamela Heaven with additional reporting from Financial Post staff, The Canadian Press and Bloomberg.

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