The Canadian dollar is growing stronger against the U.S. currency, putting Canadian companies with U.S. revenues in all sorts of pain. The trend toward a strong Canadian dollar has been persistent. The CAD has been hovering near or above parity with the U.S. dollar for months and is now 18 percent higher than it was in 2005.
Things are not going to change anytime soon. In a speech at the Woodrow Wilson Center in Washington, DC in January, Canadian Finance Minister Jim Flaherty asserted his belief that a Canadian dollar at or above parity with the U.S. dollar is set to become a permanent feature of the foreign exchange landscape.
In part, the strength of the Canadian dollar reflects the relative strength of the Canadian economy, which did not suffer nearly as much as the U.S. economy during the financial crisis of 2008, as well as its more conservative—and more sound—banking system. The strong Canadian dollar also reflects high commodity prices, since the currency is highly linked to the price of oil, Canada’s largest export.
Highlighting just how interlinked the Canadian dollar and commodity prices are, the loonie dropped from a two-year high against its U.S. counterpart as the price of crude oil fell in February.
On February 4, the Canadian currency rose to its highest level against the U.S. dollar in nearly two years on the strength of a strong Canadian government job report. Then, on February 7, the currency declined 0.2 percent to 98.94 cents per U.S. from 98.73 cents three days earlier, the strongest since May 29, 2008. The loonie appreciated 1.4 percent in the first week of February in its biggest five-day gain since Dec. 3.
While overall, the Canadian currency may be 18 percent stronger than it was in 2005, there are still daily fluctuations, which could be why Canadian companies have mixed feelings about hedging the dollar.
At a series of AFP roundtables in Canada this winter it became clear that there is no clear party line on how to handle the rising dollar. “There isn’t even a clear consensus on the direction of the Canadian dollar,” said one participant. “Typically the banks will have different forecasts but all in the same direction.” “Currently the forecasts are all over the place.” It makes it hard to decide how to handle the exposure and whether hedging is required.
Some firms reported they do not hedge at all, but others were less sanguine. To benefit from possible upside, one company in the group relies primarily on options to manage the exchange rate risk. “Our management likes to participate in the upside,” the treasurer explained. Others said their management is loath to spend upfront premiums on options and choose either not to hedge or use forwards instead.
One oil company reported at the roundtable that it has a policy of not hedging the exposure. “If we forecast the rate we will be right 50 percent of the time,” the participant said. That does not justify spending money on hedging, especially given the company’s strong balance sheet.
While there was great diversity in the approaches to the strong dollar, from not hedging at all to hedging nearly 100 percent of next year’s revenues, there were some common trends.
First, the participants agreed that firms with very strong balance sheets need to worry less about the currency fluctuation and can withstand the movement in the dollar without having to resort to hedging.
Second, most of the participants who do hedge said they did not rely on hedge accounting under IFRS for their financials. “It’s more work than it’s worth,” explained one of the roundtable participants. The general consensus was that hedge accounting is too complicated and it is easier to run the hedge results through income. “The analysts see right through it,” commented one treasurer. “And that’s what’s important.”
There is another side to the Canadian dollar story. Toronto-Dominion Bank’s $6.3 billion purchase of Chrysler Financial may well have had as much to do with a strong Canadian dollar as resurgence in consumer lending, according to the Wall Street Journal. And TD Bank is not alone. According to Dealogic, Canadian companies have spent $86 billion in M&A abroad in 2010, nearly four times as much as the previous year.
And then there is the other side of the coin—an expansion of U.S. businesses in Canada, Wal-Mart being a perfect example. It announced it is planning to spend a billion dollars to take advantage of Canada’s relatively robust economy and eager-to-spend consumers. A stronger Canadian dollar also translates into higher U.S. dollar revenues back home.