On the morning of May 13^th, the loonie hovered at just under 83 cents US, its highest level in six years. Since May 2020, the Canadian dollar has gained about 14% against the USD.

In the aftermath of the global financial crisis in 2007-08, booming commodity prices helped propel the loonie above parity. Our dollar then declined to about 70 cents US in 2015 due to falling oil prices, a strong US dollar and a rising-rate environment in the US. And now, six years later, the loonie has clawed its way back to relevance.

Why has this happened?

The loonie’s rebound is due to the convergence of a few key favourable conditions.

Commodity prices have risen. Everyone’s heard about lumber, yet the numbers are still staggering: lumber futures reached a record high of $1,670.50 per thousand board feet on May 7^th. On May 14^th, there was some reprieve for homebuilders as futures dropped to about $1,400. Even still, spot prices are still up about 78% since the start of the year, when inventories were cut back over concerns about the pandemic.

Corn is also expensive (up to $7 per bushel from $3 a year ago), copper has surged (up more than 114% since March 2020) and oil has rebounded (crude is about $65 a barrel from its $19 low in April 2020). Higher commodity prices generate income for Canada and drive up the value of our dollar.

Another reason for the surge in our dollar is the hawkish turn of Canada’s central bank. Governor Tiff Macklem acknowledged the surprisingly fast global recovery when he made Canada the first G7 country to scale back its bond purchases. He also signalled that the Bank is likely to bring forward its next rate hike from 2023 to 2022. The loonie responded like a kid just out of lockdown.

A third factor is the continued depreciation of the US dollar. With every other developed nation also turning on their fiscal and monetary taps, the greenback is no longer the only currency story in town and is no longer buoyed by relatively higher interest rates and fiscal neutrality.

What does this mean for Canadians?

Day-to-day, a strong loonie appears a good thing. Our dollar will go further when we are allowed to travel again and buying US goods is more reasonable. But it can be tougher for investors: if you earn 6% on a US investment and the loonie goes up 6%, the investment return becomes zero.

Those who ventured into the US because of weakness in the Canadian markets have been handsomely rewarded in recent years. The Globe and Mail’s Rob Carrick hailed this a smart move, especially if you didn’t have any hedging in your portfolio. But the surge in the Canadian dollar, especially in 2021, has had the reverse effect.

What’s next?

The loonie’s current level appears to be good for consumers and hasn’t yet hurt businesses. The economy – buoyed by commodity prices – has responded well from a tough 14 months.

A continued surge above 80 cents US raises issues around competitiveness. Macklem has raised the alarm, saying “If the dollar were to continue to move – particularly if it’s not reflecting good developments for Canada – that could become more of a headwind on our export projection.”

In that case, there may be a need to talk the dollar down or bring in policies to save our (so-far) promising economic recovery. The commodities rally is a boon for certain regions and sectors, but governments will come under pressure to make sure everybody benefits.

Another potential headwind is that supply will likely come back in line with demand, pushing commodity prices down as a result. This seems especially likely if some sort of return to normal is forthcoming, vaccination programs continue apace, and COVID-19 variants are kept under control. When, exactly, such a price drop may happen will depend on how quickly producers can get their inventories back up to pre-pandemic levels.

And we can’t forget the other player in this perennial currency joust: the US dollar. One could argue that further significant greenback declines look unlikely given the country now seems to be further along the path to post-pandemic recovery than many of its major-currency counterparts, including Canada.

The Bank of Canada monitors developments closely. One would expect that as inventories are restocked and the US dollar stabilizes, that the loonie, which is the best performing major currency this year, will not rise much higher.

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