Covering the USD–CAD Spread

Things are looking upbeat for Canada's economy after a few years of difficulty. That is good news for the nation overall, but the trend may eliminate the trade advantage Canada has enjoyed due to its weak currency.

With the new budget that was unveiled last week, Canada is fresh off its third consecutive year of trade surpluses. One major reason for the nation's favorable trade balance is the low value of the Canadian dollar relative to other currencies. The U.S. dollar and Canadian dollar were nearly at parity in 2012, but when global commodities markets took a nosedive, major producers like Canada were hit hard. As demand slowed for the energy-heavy exports that Canada provides the rest of the world, the value of the Canadian dollar, or "loonie," also slipped.

The Canadian economy has turned around since then. Commodity prices have rebounded, restoring Canada's ailing trade balance, and Prime Minister Justin Trudeau has promised policies that would help continue this growth. Soaring markets in the United States—one of Canada's primary trading partners—have also helped. The Federal Reserve's March interest rate increase of 25 basis points indicates that the Fed expects further growth in the U.S. economy in the near future. And as the U.S. goes, so goes Canada, generally.

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The question for Canadian multinationals, and for the foreign companies that compete with them or that do business in Canada, is whether the loonie will remain cheap if the Canadian economy continues to improve. At the time of this writing, the Canadian dollar was trading at about 75 cents to the U.S. dollar, leading many to believe that it will rise again when the currency catches up to the economy's growth prospects.

For U.S. companies that have cash flow exposure to the Canadian dollar, the recent spread has been something of a boon operationally, as loonie-denominated costs have remained in check. But what happens if the Canadian dollar closes the spread against its American counterpart? More U.S. companies than ever before are now exposed to Canada, especially small and midsize organizations. This means that forecasting and analyzing the effects of a rising loonie is crucial to these businesses' bottom line.

We recommend that finance managers take the following steps to prepare:

Focus on the data. Given the volatility of exchange rates over the past few years, corporate finance departments are increasingly equipping themselves with the types of forecasting and market-monitoring tools that were once available only to active foreign exchange (FX) traders. Many corporate financial management platforms incorporate automated data feeds that provide both real-time and historic information about FX rates. Companies are increasingly relying on these high-speed data and analytics systems to manage their FX exposures.
Consider buying forward contracts for commodities. As commodities rebound, the Canadian dollar will likely recover. For companies with significant exposures to, say, the price of oil, now could be a good time to lock in today's prices—in today's dollars—for future purchases.
Rethink financing strategies. The U.S. Federal Reserve has indicated that it will continue to raise interest rates, and Canadian policy is likely to follow suit. As borrowing costs rise, we can expect the Canadian dollar to rise as well. Companies considering a capital investment or refinancing should map out a strategy now, while rates are still relatively low.

One caveat to the rosy forecast for the Canadian economy overall is the unpredictability around the possible renegotiation of the North American Free Trade Agreement (NAFTA). If the agreement is restructured, it will likely affect U.S.-Canadian trade relations. So far, President Trump's protectionist rhetoric has largely spared America's northern neighbor, although any shift in U.S. policy toward Mexico would likely have some impact on trade with Canada.

Of course we can't predict the future, but many analysts and experts expect the loonie to close the gap against the U.S. dollar in coming months as the Canadian economy improves on rising oil prices and greater export demand. For corporate finance and treasury professionals, now could be the ideal time to rethink their cash and payments strategies to prepare for what many believe will be a more expensive loonie.

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Natasha Lala is the managing director of OANDA's Solutions for Business group, which provides a full suite of foreign exchange (FX) services, trusted by the Big Four, tax authorities, and thousands of clients worldwide. Lala has been at OANDA since 2003 in a variety of executive roles, helping clients navigate FX markets. Previously, Natasha led large-scale client-facing initiatives in the CRM, telecom, and financial industries.