China’s economic weakness dampens outlook for Canadian dollar

According to a recent poll conducted by Reuters, analysts have lowered their near-term bullish forecasts for the Canadian dollar due to a weakening Chinese economy and a growing gap between U.S. and Canadian bond yields. Despite this, analysts still expect the currency to strengthen over the next year. The median forecast from nearly 40 foreign exchange analysts predicts the loonie to strengthen by 1.9% to 1.34 per U.S. dollar in three months, compared to the previous month’s forecast of 1.32. Over the course of a year, it is expected to advance to 1.29, representing a gain of 5.8%.

Chief economist and strategist at National Bank of Canada, Stefane Marion, noted that recent factors such as widening interest rate differentials with the U.S. and weaker commodity prices due to a slowing Chinese economy have impacted the value of the Canadian dollar. China’s economic growth has slowed as policymakers aim to address a property market decline. As Canada is a significant producer of commodities, the loonie is sensitive to global growth prospects.

The Canadian dollar has experienced a 4% decline from its peak in July, while the Canadian 2-year yield has fallen further below its U.S. counterpart in recent weeks. On Wednesday, the gap between the two yields was at its highest point since May 3, favoring the U.S. note. The Bank of Canada has left its key interest rate at 5%, the highest in 22 years, citing a period of weaker growth for the economy.

Data released on Friday revealed that Canada’s economy unexpectedly contracted at an annualized rate of 0.2% in the second quarter, and growth in July is likely to have been flat. The upcoming Canadian employment data for August may provide additional insight into the strength of domestic activity. High borrowing costs are a major concern in Canada, as many Canadians borrowed heavily during the pandemic to enter the hot housing market. Additionally, the short mortgage cycle in Canada, with most mortgages having a term of five years or less compared to the common 30-year term in the U.S., further contributes to the concerns.

Marion also suggested that market expectations of no rate cuts by the Bank of Canada in the coming year may be surprising. The uncertainty surrounding interest rates adds further complexity to the currency forecast for the Canadian dollar.