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Loonie could jump up to 82 cents US if trade talks are successful, says economist

The loonie's lacklustre performance this year on trade uncertainty despite strong economic fundamentals like growth could see the currency pop if and when a trade deal is signed, according to one economist.

The Canadian dollar could rise nearly seven per cent against the greenback if a deal is made

The Canadian dollar is currently two to three per cent undervalued against the U.S. dollar, but this down from five per cent in June, according to TD economist James Orlando. (Paul Chiasson/Canadian Press)

Even with a resilient, if not strong, Canadian economy, the loonie has failed to gain momentum this year — losing more than four per cent against the U.S. dollar — as trade uncertainty ate away at its "fundamental" value.

But that could all change if a trade deal is struck between Canada and the U.S. soon, according to James Orlando, senior economist at TD Economics. He's calling for the Canadian dollar to jump to as much as 82 cents US in the near term if trade talks between the two countries are successful.   

That's a nearly seven per cent increase from the 76 cent US range that the loonie is trading at right now.

"The most important influence in the currency's rise back to around 77 U.S. cents has been hopes for a successful trade agreement," Orlando said in a note. "If a deal is indeed struck, we would expect significant appreciation in the loonie and even a potential overshoot from the 80 - 82 U.S. cent equilibrium rate."

Orlando adds that the "discount" that's being applied to the loonie's value against the greenback suggests that it is currently about two to three percent undervalued from where it should be based on fundamentals such as economic growth.

He says that's down from five per cent in June. That was the month when the U.S. ignited trade war fears by imposing tariffs on Canadian imports of steel and aluminum, along with tariffs against other countries.

"This trade-related uncertainty has been a dominant factor leaving the currency at a significant discount relative to where it would be trading otherwise," Orlando said. "When Canada is facing a disproportionate economic threat from the U.S., the Canadian dollar adjusts accordingly."

On the flip side, if a trade deal does not materialize between the countries, Orlando said the loonie could retest the 75 cent U.S. level. It was last trading at that level in mid-August.

Other drivers of the loonie

But not all analysts are as optimistic about how much the loonie would appreciate from a trade deal. 

Benjamin Reitzes, Canadian rates and macro strategist at BMO Capital Markets, said he expects the loonie to appreciate "modestly" if Canada signs a deal to 78.40 cents US by the end of the year.

He doesn't expect it to hit 80 cents US until next year.

He points out that the loonie's rise on the U.S.-Mexico deal earlier this week came "despite flat oil prices and amid narrowing interest rate differentials."

Meanwhile, Orlando does add that the loonie's correlation to interest rate differentials has increased, as it's correlation to oil prices has decreased recently.

"This goes along with the Canadian economy's recent transition towards less energy (and commodity) dependence," Orlando said.

"As this trend is not expected to reverse, it means that even greater focus will have to be given to central bank rate decisions and relative yield differentials." 

As interest rates rise, investors tend to buy the loonie, forcing up its value. Economists are widely expecting the Bank of Canada to raise interest rates again before the end of this year.

"In this regard, the increase in Bank of Canada rate hike odds at its October fixed announcement has been a factor helping pull the loonie off its June lows of around 75 U.S. cents," Orlando said.  

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