Loonie Bears Aren't Nearly Bearish Enough, Morgan Stanley Says

  • Bank joins Macquarie calling for currency to fall to C$1.45
  • Cheaper Canadian dollar would bolster exports, manufacturing

Almost no one -- from the Bank of Canada, to currency traders to Wall Street prognosticators -- grasps how far the Canadian dollar must fall to revive the nation’s economy after the collapse in oil prices, according to Morgan Stanley.

The New York-based bank has joined Australia’s Macquarie Group Ltd., both among the 10 most accurate currency forecasters, in predicting the Canadian dollar will drop almost 9 percent next year after losing a quarter of its value since 2012. The decline would push the currency to C$1.45 per U.S. dollar, the cheapest since 2003, while the median forecast in a Bloomberg survey of 73 participants is for it to bottom at C$1.35 in 2016.

The banks say everyone else overestimates how much exports outside of energy can bolster the economy. Crude oil -- until this year the country’s biggest export -- is down about 40 percent from a year ago. While the Bank of Canada reiterated confidence on Wednesday that the currency’s depreciation helps non-commodity exporters, Morgan Stanley and Macquarie say policy makers will be disappointed.

"The rest of the market may not appreciate just how much competitiveness Canada has lost in manufacturing," Evan Brown, Morgan Stanley’s co-head of U.S. foreign-exchange strategy, said from New York.

Consensus Estimate

From C$1.332 per U.S. dollar at 9 a.m. Toronto time Thursday, the Canadian dollar will weaken to C$1.35 at the beginning of next year and stabilize at around C$1.34 by year-end, according to the median forecast in the Bloomberg survey.

Morgan Stanley has the loonie falling to C$1.45 by the end of 2016, while Macquarie predicts it will reach that point in the third quarter. That translates to about 69 U.S. cents. In the year ending Sept. 30, Macquarie was the fifth-most accurate currency forecaster and Morgan Stanley was seventh, according to Bloomberg rankings.

For both, the main reason Canada’s dollar has so much further to cheapen is that the depreciation hasn’t been deep enough to deliver a big enough jolt to the economy, given the damage to the nation’s manufacturing from the years when the loonie was near parity with the U.S. dollar. A declining currency can boost exports by making the country’s goods cheaper overseas, and potentially help manufacturing recover.

‘Rough Year’

"Canada unfortunately is probably in for another rough year," Macquarie analyst David Doyle said from Toronto. "The currency has to weaken another leg down. It’s what’s required for our export-oriented industries to become adequately competitive."

The Bank of Canada may not be as pessimistic. In its decision Wednesday to leave the benchmark rate at 0.5 percent, it cited the weaker loonie and stronger U.S. growth as helping the economy adjust. The central bank and private analysts predict Canadian economic growth will quicken to about 2 percent next year, from 1.1 percent in 2015. The Bank of Canada cut rates twice this year as oil’s plunge threw the country into recession.

"The legacy of the cheapening up of the Canadian dollar will be reflected in growth in exports in the non-resource sector," said Jeremy Stretch, head of foreign-exchange strategy at Canadian Imperial Bank of Commerce. He forecasts the loonie will bottom out at C$1.36 early next year and strengthen to C$1.30 by year-end.

Investors and most economists have discounted the chance of another rate cut. The central bank’s next move will be to raise interest rates 0.25 percentage point in 2017, according to the median estimate in a Bloomberg survey.

Macquarie’s Doyle and Morgan Stanley’s Brown say that forecast is upside down.

"The market is going to have to price out hikes from the Bank of Canada and price in some chance of easing," Brown said. "A lot of manufacturers went out of business in the years when the Canadian dollar was strengthening."

(In an earlier version of this story, the final quote was corrected to show that the strengthening currency was the Canadian dollar, not the U.S. dollar.)

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