Currency expert predicts Canadian dollar to erode against global markets

Dan Tobon, Head of G10 FX Strategy, joins BNN Bloomberg to discuss the outlook for the Canadian dollar.

A foreign exchange expert made a bearish call for the Canadian dollar on Monday, anticipating the loonie will hover around 70 cents against the U.S. dollar as other currencies strengthen.

Dan Tobon, head of G10 FX Strategy at Citi Research says he doesn’t expect a major collapse in the Canadian dollar, but says a correlation with the U.S. economy, potential for deeper Bank of Canada rate cuts and a removal of positive hedge ratio adjustments will impact it.

“We’re not structurally bearish in the dollar, but certainly the next few months could still see some weaker dollars,” Tobon told BNN Bloomberg in an interview. “It’s going to be hard for the Canadian dollar independently to sell off. More likely what will happen is it’ll be both the U.S. dollar and the Canadian dollar underperforming everything else.”

On Monday afternoon, the Canadian dollar was trading at around 72 cents per one American dollar.

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Tobon said a soft patch in U.S. labour market data can weigh on the Canadian dollar due to a close relationship between both economies.

He noted that Canadian investors have been buying back Canadian dollars as they hedge their U.S. asset exposure, which has supported the currency and said this flow appears to be running out, removing a key source of support for the loonie.

“If you’re Canadian and you buy a U.S. asset, you have to sell your Canadian dollars to buy U.S. dollars to buy that asset,” said Tobon. “Historically, most investors are actually happy to maintain that, because historically, when equity markets go down, the dollar tends to perform well. It’s almost like a built-in hedge.”

“The other thing too is U.S. rates tend to be higher, so you’re actually earning some carry. This used to be a great scenario. I can buy U.S. equities, I have the dollar exposure where I’m actually earning a little carry, and it’s a hedge. In case of risk off. Things have changed a lot this year, and as we saw back in April, we saw the correlation flip, where we saw risk off, but with that risk off, a weaker dollar and higher U.S. Treasury yields. What started happening is this belief that maybe the dollar isn’t the hedge that it always was.”

He said markets are currently pricing only one more cut from the Bank of Canada over the next year but sees scope for more aggressive cuts than expected.

Despite sticky inflation, weakness in other parts of the Canadian economy could lead to deeper rate cuts as inflation normalizes amid the Canada-U.S. trade war.

“We saw a huge amount of Canadian dollar buying by a lot of the Canadian pensions in the first half of the year, especially after April,” said Tobon. “They weren’t necessarily de-risking their U.S. exposure, they were just de-risking their dollar exposure, but that effectively meant they were buying a lot of Canadian dollars over the last couple months.”

Loonie against global currencies

While some weaknesses against the U.S. dollar is expected, Tobon sees broader Canadian dollar weakness against the European Union’s euro, Japanese yen, and other currencies as a bigger concern. One Canadian dollar is trading at around 0.62 Euros and 107 Japanese Yen.

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“It’s very hard to get a situation where the Canadian dollar is weakening significantly, but maybe the Euro and Australian dollar and these other currencies are strengthening significantly,” said Tobon. “The betas effectively make the adjustment. Maybe we can get down towards US$70. That’s not a monster move from here, but it’s something that’s definitely notable. The bigger issue is, then, are we going to get broader Canadian weakness against the euro, against the yen, against these other currencies?”