The loonie is starting to lose its wings, tumbling to a two-and-a-half month low, largely fuelled by the June outlook from the U.S. Federal Reserve and — to a lesser degree — falling oil prices. The Canadian dollar dropped to 80 cents against the greenback last week, the lowest it has been since late April.

Surging demand for commodities such as lumber, along with the Bank of Canada’s hawkish tone, sent the loonie to a high of 83 cents in mid-May — its highest rate since 2015. But now it’s beginning to reverse path amid shifting global financial policies.

An uncertain Fed outlook is weighing down global currencies relative to the U.S. dollar since the central banks’s latest interest rate decision on June 16. Some Fed members said they believe the conditions needed to stem the bank’s asset purchases will come sooner than expected.

Karl Schamotta, chief market strategist at Cambridge Global Payments, told the Financial Post the Fed has effectively signalled that policymakers won’t let the economy overheat and inflation run rampant with loose policy. “The broader theme here is that you are seeing that risk aversion driving funds back to the dollar today, but the broader theme for the last couple of weeks has been the idea that inflation is not about to get out of control,” Schamotta said. “The Fed is ready and willing to tighten policy if needed, in order to stall any heating and overheating in the U.S. economy.”

Schamotta added that what we’re seeing in the currency markets right now plays into the “dollar smile” theory, which states that the U.S. dollar is expected to strengthen both because of a booming economy and a significantly weaker economy, as risk aversion sets in and pushes investors into stable currencies.

The markets are seeing the U.S. economy accelerate as it emerges from the pandemic, with 850,000 jobs added in June and more economic activity as vaccines roll out, according to the Fed’s June 16 release.

It’s also a matter of cashflow reversals, Schamotta noted. The Chinese credit cycle is turning, rebalancing the economy and lowering the demand for global commodities.

“What all of that sort of in sum does is it means the flow of cash from the U.S. economy and into the rest of the world is beginning to slow, particularly the capital flow side of things,” Schamotta said. “If anything, it’s reversing. Dollars are flowing back to the United States, global market participants are borrowing less and that is weighing on virtually every currency relative to the dollar.”

While global financial policy takes centre stage as the culprit for a weaker Canadian dollar, the plunge in oil prices have also played a muted role. Crude prices slid nearly 4% during the first half of the week of July 5. The tumbling price comes from an ongoing OPEC+ meeting dispute between Saudi Arabia and the United Arab Emirates (UAE), after the UAE demanded the Saudis raise their oil production to adhere to the terms of a pact made last year to cut supplies amid plunging prices. The organization is expected to scale back the cuts made in 2020, which has been taking 6 million barrels per day of output off the market, but talks to boost production have fallen flat.

Source: Financial Post