Amid all the hand-wringing and finger-pointing about a near-par Canadian dollar, George Vasic has a revelation: A 95-cent (U.S.) loonie actually doesn't look overblown at all.
In a research report this week, UBS Securities Canada Inc.'s chief economist and chief strategist argued that the people who say the currency is overvalued may be fixating on its historical relationship with commodity prices - which, he readily agreed, suggests a much lower fair value for the dollar.
However, when he took into account several other key factors that influence the loonie, he found that a value in the mid-90s - where the currency has lingered for several weeks - looks spot-on. And none of those factors are the dreaded black box of "speculation" that many observers trot out to explain away the dollar's surge.
It's not just about
commodities any more
"For the longest time, commodity prices were all you needed to know in relation to the CAD. At this point, however, commodities would only suggest a CAD in the mid-80s, and so other factors have also become influential," Mr. Vasic wrote.
Those factors are:
The euro/U.S. dollar exchange rate;
The Canada/U.S. public sector debt ratio;
The Canada/U.S. bank rate spread;
The global equity risk appetite.
When Mr. Vasic combines these factors with the better-known impact of commodity prices - creating a five-factor model for Canadian-dollar influences - he finds a near-perfect correlation with the loonie's performance, and not only recently.
Movements in the five-factor model and the dollar are 96 per cent correlated over the past 15 years, topping the dollar/commodity correlation of 89 per cent.
All arrows pointing upward
The dollar's rally has come when four of these five factors have been heading decidedly upward. The only exception is the rate spread between the Bank of Canada and the U.S. Federal Reserve Board, which has held steady for the past six months - although Canada is widely expected to begin raising rates well before the Fed does, which is considered a key influence on currency traders' expectations.
The rise of commodity prices has been somewhat less dramatic than the gains in some of the other factors in recent months - which, he suggested, fuelled the misconception that the loonie had overshot.
"It's not that these [other] factors were not previously significant, it is that they did not take a particularly divergent path [from commodities], and so their impact on the CAD was not visible compared with the swings in commodities," he said. "This has now changed."
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IT MAY BE LOONIE, BUT IS IT UNFAIR?
The Canadian dollar's historically close correlation with commodity prices has broken down recently, leaving it far above the mid-80 cents (U.S.) level that commodity pricessuggest would be fair value. But UBS strategist George Vasic says that if you look at a basket of five key loonie-influencing factors (including commodities) taken together, the loonie looks fairly valued.
THE GLOBE AND MAIL SOURCES: BANK OF CANADA, STATISTICS CANADA, UBS, OECD
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