How much further for the falling loonie?

Bearish sentiment prevails, but remember that markets thrive on surprises

2025 has barely begun and already markets have served up enough volatility to derail even the most disciplined dry January practitioners. With Trudeau’s “sunny ways” now a distant memory and Trump now inaugurated as 47^th president of the U.S., trade and tariffs are looming large in the minds of Canadians.

But, if our inbox is any indication, the burning question is whether the robust gains of 2024 can carry forward into the new year. For Canadian investors, last year’s U.S. equity rally came with an extra kicker – currency conversion effects. With the loonie sliding 8% versus the USD (its largest annual decline since 2015), unhedged U.S. dollar-denominated investments delivered outsized returns for Canadian portfolios.

What drove the loonie’s decline?

Unlike past routs in CAD driven by recessions or oil price crashes, last year’s retreat reflected a stark divergence between U.S. and Canadian dynamics. While America could seemingly do no wrong last year, news flow north of the border was grim. In March, the Bank of Canada declared a “productivity emergency” – an unusual move for an institution traditionally dedicated to monetary policy. The data, however, speaks volumes. Canada’s capital stock of machinery and equipment has shrunk 2.8% since peaking in 2014, marking seven years of decline out of the past eight – an unprecedented stretch in records dating back to 1961. A lack of international competitiveness continues to be Canada’s longer-running issue.

Without the cushion of gushing oil revenue last year (Canada’s largest export), other structural issues also became hard to ignore: high household debt; weakening domestic consumption; rising unemployment; and lower interest rates. Then, toss in Trump’s tariff threats and colourful plans to redraw the map of America to include a 51^st state, and the challenges intensified.

Catalysts for a turnaround

In financial markets, astute investors always ask how much bad news is already priced in? For the loonie, we believe a significant portion has been. The real effective exchange rate (REER) has fallen to levels last seen in the 1990s.

Sentiment is also overwhelmingly bearish, with short positions in CAD near decade highs. While investors have had ample time to factor in Canada’s headwinds, catalysts for a reversal are less discussed. Here’s where upside surprises could emerge:

Economic rebound: While interest rate differentials are a driver of currency movements, economic growth also plays a significant role. After five consecutive rate cuts (and more to come), Canada’s highly interest rate-sensitive economy is poised for cyclical improvement. Canada’s housing market is already firming, showing that rate cuts are taking effect. Meanwhile, a weaker starting point for the currency boosts export competitiveness, creating a tailwind for trade that could help mitigate the impact of any tariffs implemented in the months ahead.

Political shift: With Prime Minister Trudeau stepping down, polls suggest a near-certain conservative majority in the next election. A more business-friendly government will bolster market confidence and attract investment flows.

Global recovery: Canada’s small, open economy reacts more to global macro trends than domestic developments. Our investment team anticipates that the U.S.-led recovery is now in the process of broadening globally. Trump’s trade wars have already catalyzed easing interest rates and heightened fiscal stimulus in economies outside America (see our latest “Super Trends” outlook). Historically, periods of firming global growth have coincided with Canadian dollar strength. We see no reason this time will be different.

Investment implications

The Canadian dollar is just one casualty of the “America first” theme. A long list of currencies and international asset classes – with far better macroeconomic fundamentals than Canada – are now priced for near-apocalyptic economic outcomes. Yet heading into 2025, the consensus continues to hold that America has what the rest of the world lacks: corporate leadership; innovation in the seemingly limitless world of artificial intelligence; and, in the words of incoming Treasury Secretary Scott Bessent, a “growth mindset.” Unsurprisingly, strategic U.S. equity allocations remain pinned at record highs.

But, looking closer, America also has many things that the rest of world would rather avoid: a frothy stock market; an overvalued currency (according to Bank of America, the most overvalued in history); and an increasingly ornery and uncooperative domestic bond market (30-year Treasury yields have risen 100 basis points since mid-September). Elevated valuations and high expectations naturally dampen future returns.

History, however, reminds us that markets thrive on surprises. Turning points often present the greatest opportunities. For Canadian investors, conditions are falling into place for a bottoming process in the loonie and other deeply undervalued foreign currencies and asset classes. But with the world’s leading stock market showing unmistakable signs of exuberance and Trump’s tariff rhetoric set to intensify, some turbulence should be expected in the months ahead.

Still, now is the time to prepare portfolios for these pivotal shifts. With the bull market likely to broaden in 2025, the case for global diversification – and the opportunities it presents for macro investing – has rarely been more compelling.

Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. This article first appeared in Forstrong’s Insights Page. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com. Follow Tyler on X at @TylerMordy and @ForstrongGlobal.

Disclaimers

The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Performance statistics are calculated from documented actual investment strategies as set by Forstrong’s Investment Committee and applied to its portfolios mandates, and are intended to provide an approximation of composite results for separately managed accounts. Actual performance of individual separate accounts may vary with average gross “composite” performance statistics presented here due to client-specific portfolio differences with respect to size, inflow/outflow history, and inception dates, as well as intra-day market volatilities versus daily closing prices. Performance numbers are net of total ETF expense ratios and custody fees, but before withholding taxes, transaction costs and other investment management and advisor fees. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

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