Fears of a U.S. interest rate hike hung over the markets a day after steep stock selloffs, with the Canadian dollar pushed down by a strong greenback.

The Canadian dollar continued its fall against the U.S. dollar,closing at 78.42 US cents, near its lowest level this year. 

"The loonie is down for a whole host of trends and the biggest trend is a strong U.S. dollar against all major currencies," said Camilla Sutton, chief foreign exchange strategist at Scotiabank.

"The real takeaways are the [U.S. Federal Reserve is] likely to tighten rates and other central banks aren’t. We have oil prices that are moving to new lows and we have sentiment favouring a higher U.S. dollar and all of it has come together and weighs heavily on the Canadian dollar," she said.

She predicted the loonie would fall to 75 cents US. 

The euro was at its lowest point since April 2003, closing at $1.06 US. The euro is down 12 per cent this year against the U.S. dollar and many traders expect it will fall to parity with the greenback.

And there were further dire warnings over the stock market, with Deutsche Bank AG analyst David Bianco predicting the S&P index could fall by as much as nine per cent if the U.S. Federal Reserve raises interest rates in June.

The S&P, a broad index covering 500 stocks representative of the U.S. economy, has been trading at or near record levels since mid-February on strong corporate earnings and optimistic economic predictions for the U.S.

What’s causing all the worry is the divergent monetary policies by central banks in Canada, the U.S. and Europe.

The Bank of Canada cut interest rates in January in an effort to stimulate the Canadian economy and the European Central Bank has begun an even more extreme stimulus plan, buying up $80 billion Cdn of bonds every month.

Meanwhile, the Fed appears to be heading in the opposite direction. Fed chair Janet Yellen has said she can afford to be patient on rate hikes, but she has set some benchmarks for when she’ll move, among them an unemployment rate of 5.5 per cent.

U.S. jobless rate at 5.5%

The U.S. met that target last Friday, with a solid pace of jobs growth that has continued for six months. Other economic indicators also appear to be pushing the Fed to move sooner, rather than later, including strong consumer confidence and a growth rate in the fourth quarter that is somewhere between 2.2 per cent to 2.6 per cent, according to the latest estimates.

Most analysts believe the rate hike will come in June, though the Fed’s open market committee meets next week and may give clearer guidance on its plan.

In anticipation of that day, investors are buying up the U.S. dollar, pushing it up against the euro and the loonie.

They’re also anticipating a hit to U.S. stocks, which have seen a six-year bull run since their low in March 2008.

On Wednesday afternoon, the S&P was up most of the day, but ended lower, losing four points to 2040, the Dow fell 27 points to 17,635 and the Nasdaq dropped nine three points to 4849.

The TSX was up 90 points at 14,731. Yesterday’s rout took Toronto stocks to the same level they were at at the beginning of the year.

Canadian stocks are more susceptible to the price of oil and other commodities, because the strong mining and energy sectors.

The West Texas Intermediate oil contract was flat today at $48.37 US a barrel. The price did not dip substantially, despite a report from the U.S. Energy Information Administration that crude oil inventories were at their highest level since 1982.

The strength of the loonie over the next few months could depend in part on Canada’s employment picture, according to Rahim Madhavji of Knightsbridge Foreign Exchange in Toronto. Statistics Canada is set to report the latest unemployment numbers this Friday.

Shaun Osborne, chief foreign exchange strategis at TD Securities, said there’s been a return to volatility in the financial markets after a calmer period.

"We haven’t been in this situation for quite a period...  Over the past four or five years, we haven’t had this divergence in growth outlook between Europe and the U.S.," he said in an interview with CBC's The Exchange with Amanda Lang.

Similarly, it's a long time since Canadian and U.S. monetary policies were headed in opposite directions, he added.