Canadian dollar’s downward trajectory against the USD started in 2015 when the loonie sunk significantly against the U.S. dollar. Since then, it has become very difficult for the CAD to surpass the USD.
Several factors have contributed to the CAD’s weakness against the USD, including the plunging oil prices. Economic factors such as inflation rates, interest rates, and prices of commodities also have a hand in the varying USD/CAD currency exchange rates.
This guide explores some of the reasons the Canadian dollar is weaker than the U.S. dollar. Before we look into that, let’s remind ourselves about the USD/CAD relationship.
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Understanding the Basics of the USD/CAD Currency Pair
The USD/CAD currency cross represents the quoted rate to exchange the USD against the CAD. It’s the amount of Canadian dollars you can receive for each U.S. dollar. For instance, a USD/CAD rate of 1.23 means 1 U.S. dollar is equivalent to 1.23 Canadian dollars. In other words, you’ll get 1.23 CAD for each U.S. dollar during a foreign exchange.
The USD/CAD pair has achieved parity at various points in history due to business ties between the two countries. However, the U.S. dollar has always been stronger than the Canadian dollar. Let’s find out why.
Why is the Canadian Dollar so Low Compared to U.S. Dollar
A vast range of economic factors determines the currency exchange rates between the CAD and the USD. The upward and downward pressures on the currency rates get influenced by the supply, demand, and other underlying aspects of the economies.
Now, let’s look at the factors that have affected the CAD’s strength against the USD.
Currency Movements in the Open Market
The strength of the U.S. dollar and Canadian dollar gets dictated by the supply and demand forces in an open market. Most Canadians who buy products from the United States will trade the Canadian dollars for U.S. dollars.
Since there’ll be an open market demand, the price will increase. Whenever Canadians want to buy products from the United States, they must sell their Canadian dollars and buy the U.S. dollars. That will increase the demand for U.S. dollars.
On the other hand, the supply of Canadian dollars will rise. In the end, the exchange rate of the USD will increase against the CAD.
Plunging Oil Prices in Canada
The Canadian dollar started to weaken in 2014 when a loonie was worth 93 cents USD. It was after OPEC had a meeting with the stakeholders to discuss the decreasing demand for oil on the global market, despite the high supply of oil.
Everyone expected OPEC to cut the production of oil to decrease supply. It would have naturally raised the oil prices back to normal as oil users worldwide would have had to fight for the limited oil supply. Surprisingly, OPEC decided not to cut oil production.
OPEC’s decision significantly affected oil-exporting countries, including Canada. The global oil demand was falling while supply remained the same. As a result, the oil prices reduced worldwide, negatively impacting the currencies’ strength.
Since Canada is among the largest oil exporters to the United States, the plunging oil prices affected the USD/CAD exchange rates. Since then, the impact has spread up to date. Any change in the demand and supply of oil affects the exchange rates.
When the oil prices go down, it will be cheaper for the United States to import oil from Canada. On the other hand, it will be a bit harder for Canada to offer competitive oil prices. The low oil prices will be beneficial for the U.S. but detrimental for Canada.
So, the Canadian dollar is low because the current global demand for USD is high. And since the oil prices are plunging and hitting the economy, the flow of money into the Canadian dollars is significantly lower.
The U.S. Economy is Stronger than Canada’s
In 2015, the USD was already gaining strength against many currencies, including the Canadian dollar, due to its strengthening economy. The U.S. Federal Reserve hiked the interest rates, further strengthening the United States dollar against the Canadian dollar.
One factor that has seen the U.S. currency improve in strength is the high-yielding U.S. government bonds. The Canadian government bond’s yield remained weak. Many foreign investors developed an interest to invest in American high-yielding bonds.
As foreign investors purchase the U.S. treasury bonds, they will need to purchase U.S. dollars, putting more pressure upward on the U.S. treasuries. As a result, the economic performance of the United States has become stronger than Canada’s economy.
Higher Interest Rates in the U.S.
Another factor that affects the USD/CAD currency exchange rate is a change in interest rates. Unlike the Bank of Canada, the U.S. Federal Reserve offers higher interest rates on government securities, including high-yield bonds.
Since the United States’ interest rate is higher than Canada’s, the USD has appreciated against the CAD over time. That’s because the higher interest rates offer higher rates to lenders, attracting more foreign capital that increases the currency exchange rates.
The Bank of Canada can strengthen the Canadian dollar by increasing the country’s prime lending rate. That will increase the interest rate offerings, which can effectively shift the demand for the CAD. Foreign investors will be ready to invest in Canada.
If foreign investors see the high interest rates in Canada, they will likely want to obtain securities purchasable in Canadian dollars. Investors will only buy Canadian securities when the Canadian dollar’s performance is likely to improve in the future.
Conclusion
The U.S. economy made a quicker recovery than Canada in 2014, finally overcoming the Canadian dollar. By the end of the year, the U.S. dollar was worth significantly more than the Canadian dollar. As the oil prices decreased gradually, Canada lost its economic advantage in the energy sector. As a result, the USD climbed even more.
