More Bad News for the Canadian Dollar?

This may not come as a surprise anymore, but the Canadian dollar is in real trouble. After months of edging lower and lower, the CAD to USD exchange rate looks like it’s going to break sometime in 2016. Here’s where it could be headed.

No one has a “Magic 8” ball to figure out what can happen to the Canadian dollar. The best we can do is simply watch for signs of impending doom. Unfortunately, there are plenty of those at the moment, from the housing crisis to a weak natural resource sector.

But by far the worst omen for the CAD to USD exchange rate comes from the U.S. dollar’s side of the equation. The Federal Reserve hiked interest rates last week and the move completely changed the Canadian dollar forecast.

After all, the Fed didn’t decide to raise rates out of the blue. It did so because underlying economic conditions were improving in the U.S., which is the opposite of what happened in Canada. Canada’s economy slipped into a recession during 2015.




Junk Bonds Take a Hit

Many analysts were genuinely worried about the impact of a rate hike in the U.S. dollar. They claimed the American economy hadn’t recovered enough and that higher interest rates would just cripple borrowers. But that was both simplistic and wrong.

Interest rates had been near zero for seven years, meaning that borrowers with a great credit score had access to money that was virtually free. Even junk bond yields were lower by association, but that was a temporary scenario.

It wasn’t the normal state of affairs, but an aberration, a freak occurrence that shouldn’t be taken as precedent. Companies that shouldn’t have been able to stay afloat were able to because investors forgot how to price risk properly.

However, in the run up to the Federal Reserve’s meeting, investors seemed to wake from their slumber. The reality they found was not pretty. Junk bonds were not the tidy, little income-generators they thought and one by one, the junk bond funds began to fall.

Third Avenue Management stopped granting exemptions on a junk bond fund with assets of $788 million. Soon after, Stone Lion Capital Partners and Lucidus Capital Partners went down the same drain, the latter taking $900 million with it. (Source: “Investors See Third Avenue Fueling More Bond Market Carnage,” Bloomberg, December 13, 2015.)

Chart courtesy of www.StockCharts.com

So yes, a bunch of bad debt got wiped out, but good debt stayed pretty even. There was a minor spike in the days leading up to the rate hike, but markets calmed down in a hurry once they heard the verdict. They understood that it was a good sign and the U.S. dollar rose.

CAD/USD: Headed Off a Cliff

By itself, the U.S. economy looks like an out-of-shape person running a marathon. It took a long time and there was a lot of panting, but they eventually crossed the finish line. However, in comparison to Canada’s economy, the American economy looks like a professional athlete.

The Canadian economy slipped into a recession during the first half of 2015. More than 35,000 jobs were lost in November and the coffin is closed on the country’s largest export sector—all negative signs for the “loonie.” (Source: “Canada sheds 35,700 jobs in November, unemployment rate up to 7.1%,” CBC, December 4, 2015.)

With another decline to match the near 20% drop in 2015, the Canadian dollar to USD exchange rate could fall as far as $0.57.

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