The re-election of Donald Trump has supercharged the U.S. dollar, sending Canada’s currency exchange rate to a four-year low against the greenback – potentially helping Canadian exporters ride out the impact of tariffs but also pushing up prices for imported goods.
The loonie has fallen around 2 per cent against the U.S. dollar since the election and around 4 per cent since September, when financial markets began leaning into the “Trump trade” in expectation of the Republican candidate’s return to the White House. It’s now trading near 71 US cents, down from around 74 US cents in late summer – a level last seen in the early days of the COVID-19 pandemic.
The recent exchange-rate move is largely a story of U.S. dollar strength, and Canada’s currency has held up better than other major currencies, including the euro and Japanese yen, which have been clobbered since Mr. Trump’s re-election.
At the same time, the weak loonie reflects a broader economic malaise in Canada, which has led investors to focus on opportunities south of the border and pushed the Bank of Canada to cut interest rates faster than the U.S. Federal Reserve to avoid a recession. This interest-rate divergence is expected to grow, keeping downward pressure on the loonie in the coming quarters, to the benefit of exporters who become more competitive, and the detriment of Canadian shoppers, who have to pay more for goods that come across the border.
“I would see the exchange rate more reacting to the different economic performance, rather than the economic performance reacting to the exchange rate,” Bank of Canada Governor Tiff Macklem said during a Senate committee appearance last month. “The U.S. economy has had stronger growth, and importantly, it’s had much stronger productivity growth than Canada.”
In recent months, global bond and currency markets have been driven by the prospect of Mr. Trump’s return to the White House, alongside stronger-than-expected U.S. economic data that have rolled back bets on rapid interest-rate cuts from the Fed.
Mr. Trump is promising tariffs, corporate tax cuts and deregulation – a policy mix that’s expected to boost domestic economic growth, increase the U.S. government deficit and fuel inflation. Investors have responded by pushing bond yields sharply higher, with the yield on 10-year U.S. Treasuries up almost a full percentage point since mid-September.
Higher U.S. interest rates and a surging equity market pull in foreign capital, which bids up the greenback. There are also two sides to every currency trade, and Mr. Trump’s tariff proposals stand to hurt countries that export to the United States, causing their currencies to depreciate. Meanwhile, his “drill, baby, drill” approach to energy production could put downward pressure on oil prices, further weighing on commodity-oriented currencies such as the Canadian dollar.
“The tariffs plus the deregulation and the stimulus and the pro-growth policies come in first and those things kind of make the rest of the world weaker,” said Mark McCormick, head of foreign-exchange strategy for TD Securities.
The Trump trade is happening on top of surprisingly strong U.S. economic data. While growth in most advanced economies has slowed to a crawl under the weight of high interest rates, the U.S. continues to churn out fairly robust gross domestic product and jobs numbers, as well as sticky inflation data. On Thursday, Fed chair Jerome Powell said he and his team are in no rush to cut interest rates.
The picture is very different in Canada, where inflation and economic growth have both surprised to the downside. The Bank of Canada was the first G7 central bank to begin lowering interest rates, and it has cut four consecutive times since June, bringing the policy rate to 3.75 per cent from 5 per cent. By contrast, the Fed’s policy rate target is currently 4.5 per cent to 4.75 per cent.
“I wouldn’t worry about the Canadian dollar depreciating on its own. I would worry about the underlying reason why the Canadian dollar has depreciated. And that points to consumption and investment weakness and also exports,” said Ke Pang, an associate professor of economics at Wilfrid Laurier University.
Economists and traders expect the gap between Bank of Canada and Fed interest rates to keep growing. Mr. Macklem has said there is a limit on how far the two central banks can diverge. But he has maintained that the banks are not close to that limit and that concerns about Canadian currency weakness aren’t influencing monetary policy.
“The limit has to do with the inflationary consequences of a weak dollar,” said Martin Eichenbaum, economics professor at Northwestern University in Chicago. “Imagine that you really diverge, the nominal exchange really goes down the toilet. Canada has to import goods and inputs to what it’s doing. That will show up as inflation in Canada, which would be precisely the opposite of what Tiff would want. So, he’s balancing these two things.”
A Bank of Canada paper from 2015 estimated that a 10-per-cent depreciation in the Canadian dollar increases core inflation by around 0.3 percentage points and total consumer price index inflation by 0.6 percentage points. More recent internal estimates are in the same ballpark, a bank spokesperson said.
At this point in the economic cycle, inflation, which is running below 2 per cent, is not the bank’s biggest concern. Central-bank policy makers have said they’re increasingly worried about downside risks to economic growth and inflation. And here a weaker currency, in tandem with rate cuts, can actually help.
“A weak currency has some distinct advantages,” said Eric Lascelles, chief economist at RBC Global Asset Management. “It does boost a country’s competitiveness, which you could argue is precisely what the doctor ordered for Canada with a woeful productivity performance. Canadian exports are suddenly cheaper relative to U.S. domestic products.”
Bay Street analysts largely expect the U.S. dollar to continue to strengthen and the Canadian dollar to slide in the near term. However, there are reasons to think this might reverse in the medium term, Mr. McCormick of TD said. Despite policy proposals that have strengthened the U.S. dollar, Mr. Trump has said he would prefer a weaker currency to help U.S. manufacturers and exporters.
“I do think we will see the conditions where the dollar strengthens to levels that are extremely uncomfortable and are very disruptive for the whole world. Then in turn, Trump tries to fix it and then takes credit for fixing the problem that he created. And that’s what kind of sows the seeds of the weaker dollar that we’re kind of anticipating towards 2026,” Mr. McCormick said.