The loonie made headlines in the last week of February, cracking 80 U.S. cents for the first time in three years. The Canadian dollar then weakened, falling back to 79.39 U.S. cents after surging U.S. bond yields roiled global stock markets. 

But some economists think that its run is far from over. The currency has risen more than 15% against the U.S. dollar from its low in 2020, and Capital Economics believes “the outlook for the Canadian dollar remains bright for the rest of 2021.”

Capital thinks the currency was undervalued when the pandemic began, and is not yet at the point of overvaluation. It also expects the spread between 10-year government bond yields in Canada and U.S. to close, offering further support.

But the key driver will be oil, the economists said. Oil prices have had a record start to the year, with U.S. crude futures up nearly 22% in February, on expectations of short supply and increasing demand.

Though most of the Canadian dollar’s gains over the past year have been driven by the weakening U.S. dollar, “more recently, the loonie’s old friend — commodity prices — has been increasingly dominating the picture,” said BMO chief economist Douglas Porter. Capital believes the rebound in oil prices has already resulted in a recovery of Canadian oil production and will lead to a surprise rise in first-quarter GDP, despite COVID-19 lockdowns.

The surge in natural resources will get stronger as the global economy comes back to life, and the economists predict WTI crude will rise to US$67 by the end of the year. (Brent was at US$66.33 a barrel on February 25, and WTI at US$62.95.)

With this wind beneath its wings, the loonie should soar to 84 US cents by the end of 2021, said Capital. But enjoy it while it lasts — or not. (The Bank of Canada has already signalled its concern that a high-flying loonie drags on trade.)

Capital thinks higher oil prices won’t last in 2022 as global production picks up, forecasting a price of US$53 by the end of that year. While the lower oil price likely won’t affect the spread between Canadian and U.S. bond yields, it may lower expectations that the Bank of Canada will raise rates before the U.S. Fed., thus keeping the loonie’s flight in check.

Therefore, Capital is cutting its forecast for the Canadian dollar from 85 US cents by the end of 2022 to 82 cents. But some are more upbeat on oil. As Yadullah Hussain wrote in Posthaste, bullish reports on oil’s prospects have been coming thick and fast lately, with Bank of America predicting Brent could hit US$100 by 2026.

Source: Financial Post