Has the Canadian Dollar Hit Bottom? Not Likely.

Markets have been beating down the Canadian dollar, but there’s still room for the CAD/USD exchange rate to drop further. Imagine, for a moment, that we are one year in the future, looking back at the previous 12 months. What would we see and where did the last 12 months lead us?

The evolution of the Canadian economy in 2016 is impossible to guarantee, but we can make an educated guess by viewing it as an extension of everything that has already happened. From that vantage point, the Canadian dollar outlook for 2016 is hideous.

After all, things haven’t been great on the ground. Weak oil prices have decimated a major part of Canada’s export industry, the mortgage bubble grew more fragile, and the world economy stumbled in the wake of global conflict.

We cannot pretend like the Canadian dollar slump is simply a product of poor seasonal sales or a momentary lapse in economic growth. Canada was in recession for the first half of 2015. Is it any surprise that the “loonie” (a nickname for the dollar) is at its lowest level since 2004?

However, the worst is yet to come.

Housing Crash Could Destroy the Canadian Dollar

Canada’s economy was slightly insulated from harm by the housing boom in Toronto and Vancouver, but that bubble is showing signs of strain. Home prices may decline more than 20% in the next two years, according to the Organisation for Economic Co-Operation and Development (OECD). (Source: “20% housing correction would push young homeowners under water, ” CBC News, November 9, 2015.)

The Canadian dollar would get crushed if both its housing and real estate sectors were hit at the same time, yet it looks like that’s exactly what is happening. We’ve seen enormous amounts of cash drawn to Toronto and Vancouver in much the same way that the U.S. fed its housing bubble. Speculation and leverage, that’s all it takes to engineer disaster.

If you take a drive around Toronto or Vancouver, it becomes all too apparent that rising home prices aren’t a simple story of supply and demand. Sure, a lot of people move to the big cities and are willing to bid up the price on a condo. But that still doesn’t account for the kind of rapid pace we’ve seen in the Canadian housing market.

The truth is that Canadian housing became known internationally as a convenient place to park funds and earn a great return. Housing markets never crash, right? The influx of capital to Canadian real estate helped boost the Canadian dollar over the last 10 years, but there was a massive hidden cost. (Source: “Foreign investors avoid taxes through Canadian real estate, ” The Globe & Mail, October 7, 2015.)

Wages for the average Canadian worker weren’t rising at the same rate. Mortgage payments started eating up a larger portion of disposable income, forcing people to take out loans to stay afloat. The debt never stopped mounting.

When Could the Canadian Dollar Collapse?

Canada’s ratio of household debt to disposable income is at dangerous levels, topping 163% in the first quarter of 2015. That means for every dollar Canadians have to spend, they have $1.63 in loans. It means the Canadian dollar is vulnerable in the event of a downturn. (Source: “Canada household debt ratio hits new record of 163.3%, ” Financial Post, March 12, 2015.)

As if all this wasn’t enough, the Federal Reserve is planning on hiking interest rates this month. A small rise in the federal funds rate will send the U.S. dollar soaring, thus weakening the relative power of the Canadian dollar.

Considering that Canada is already at risk of devaluing the dollar with its monetary stimulus program, the combination of factors could push the loonie lower than we’ve ever seen. It wouldn’t be impossible for the CAD/USD exchange rate to drop as far as $0.65, $0.63, or even $0.61.

Courtesy of Profit Confidential, by Gaurav S. Iyer