Last week the US Federal Reserve increased their target overnight lending rate by 0.25%. This is the first upward move by the Fed since the big financial crisis. What does this mean for the Canadian dollar?
First, when the interest rate in a country increases relative to other countries then purchasing financial products in that country becomes more attractive. When more people want to buy things in your country, there is a bigger demand for your currency. This will drive up the exchange rate in whatever country increased their rate. The Loonie has already taken a beating with low oil prices and the (correct) speculation that the Fed would make this move at the end of 2015. With rumours of a further increase in rates by the Fed in 2016, things are not looking good for a Canadian dollar recovery.
Second, oil is priced in US Dollars. All other things being equal, when the US dollar is stronger the price of a barrel of oil is lower. This is why the Canadian dollar is so sensitive to American currency fluctuations compared to other countries around the world. We get hit with the interest rate effect but our dollar is also strongly tied to the price of oil in the markets. On top of that, the US ban on oil exports has ended and the members of OPEC seem to have parted ways. This means that the price of oil is unlikely to rebound significantly in 2016.
Under those to two effects we are seeing some 11 year lows for the Canadian dollar and we can expect that to be the norm in 2016. The Bank of Canada has mentioned that negative interest rates would be something they would consider if they believe it will help. If we moved to negative rates while the US was increasing theirs we would see another drop down below 70 cents USD.
The best case scenario for Canada is that the US economy is actually at the beginning of a strong recovery. Since they buy 75% of our exports, they will be buying more of everything that we make. That can help our economy and keep our dollar from sliding further.