How low can the loonie go? A look at how to decide: Don Pittis

Now and again over the years, acquaintances at the CBC planning a trip abroad have popped by to ask me where the Canadian dollar is going next. With one investment bank, Macquarie, predicting the loonie is heading for 59 cents US, it's no longer just travellers who ask.

Rather than explaining how impossible it is to predict the value of currencies and how I would now be living a life of luxury on the avails of currency speculation if I actually knew, I've learned to give a short answer that always seemed to satisfy.

Before getting to that, I thought it worthwhile to offer up a slightly longer answer about what causes currencies to rise and fall to help you to reach your own conclusions about the future value of the loonie.

• Stock markets sharply lower as loonie sags
• A 59-cent loonie? It could happen this year, investment bank says

Predicting where a currency will go next matters to most Canadians because of a holiday or worries about the cost of imports, but it is also a high-stakes game played by the world's biggest financial institutions. Currency traders buy and sell trillions of dollars' worth of dollars, dinars and dong every day.

An inexact science

And completely unlike what you might think, considering the money at stake, deciding on the correct price of a currency is far from an exact science. Not only that, but currency values zig and zag on very slender news. Yesterday the loonie traded up and down by almost a full cent while nothing really important happened. Traders notoriously run with the pack, selling when others are selling and buying when others buy.

A market based so heavily on psychology means smart traders don't need hard data on currency flows so much as information on triggers that they think will make others buy or sell. Barring hard news on changes in interest rates, day-to-day trading is self-referential. To put it politely, it is like a snake eating its own tail.

In other words, the same gossip that influences you, including Macquarie's predictions that the loonie will plunge to 59 cents against the greenback, is also affecting currency traders, even if they scoff at the prediction. 

In the case of the loonie, one of biggest drivers everyone has discussed is the falling price of oil. 

It does not take much deconstruction to convince you that oil should not be nearly so influential on the Canadian dollar as many have said. As oil and other resource exports fall in value they become a smaller and smaller part of Canada's economic activity, and have less influence on our currency.

Yesterday, for example the Canadian currency plunged to new lows while oil actually closed higher. ​

"As the term 'petroloonie' suggests, most investors are aware that the value of the Canadian dollar follows the price of oil," wrote Scott Barlow in Tuesday's Globe and Mail before going on to slam the idea, pointing out that a better indicator of the value of the loonie was the relative return of Canadian and U.S. bonds.

Poloz rate cut?

The 59 cent advocates at Macquarie think Bank of Canada governor Stephen Poloz will announce a cut in rates as part of next Wednesday's Monetary Policy Report. If the Bank of Canada does cut rates, Barlow suggests the loonie will fall to 67 US cents.

For what it's worth, what I heard in Poloz's last speech was not another cut in rates. He implied the low dollar was already beginning to work its magic. All we had to do was wait. To cut rates again would be like turning the thermostat up to 30 C when you're cold, then opening the window when it inevitably gets too hot.

The fact is, large and frequent shifts, up or down, in the value of currency are not good for an economy. With profit margins thin, the success or failure of exporters and importers begins to depend more on the whims of currency, rewarding a lucky guess more than good products and efficient management. Repeated swings could well discourage small producers from taking the leap beyond Canadian markets, the crucial step that Poloz says is needed to rebuild the non-resource export economy.

• The race for world's crummiest currency
• Canadian loonie: what the world looked like on past lows

The other confusing thing is that despite a huge wave of gloom just now, it would not take much to reverse the slide in the price of oil. After all, the banks that are now predicting $10 and $20 dollar oil completely failed to foresee today's $30 price tag, otherwise they would have shorted the world supply and now be very rich indeed.

The same goes for the people forecasting extreme changes in the value of the loonie with such confidence. If they had really known, would they still be working as bank analysts, or would they be sailing their yachts off Monaco? 

So what should Canadians do? Deciding where to invest is in many ways the same problem as the one faced by people taking trips abroad. If you put your money into the U.S. dollar and the loonie rises, you lose. Ditto if the loonie falls and you fail to switch currencies.

My advice to travellers is now always the same. "Switch half now," I tell them, "and half when you travel." Split the difference and no matter which way the currency swings, you feel as if you are better off than you might have been.

Follow Don on Twitter @don_pittis

​More analysis by Don Pittis​