THE CANADIAN DOLLAR IS OVERVALUED

The TD Economics department put out an interesting research piece on the value of the Canadian dollar arguing that the loonie is slightly overvalued.

The research piece argues that, although there are strong macroeconomic reasons for the rise in the Canadian dollar, three forecasting models tested argue that the level hit by the loonie in the fourth quarter of 07 – when it reached $1.10 to the US dollar – is not sustainable. Their three models give the loonie a value of $0.93 - $0.95 US.

Below are graphs displaying the actual value of the loonie and the value implied by their three models (a Purchasing Power Parity approach, a Behavioural Equilibrum Exchange Rate model, and the Bank of Canada model). Note that all these models show the dollar to be above the forecasted (i.e. explainable) level. They also have a great graph showing the correlation between commodity prices and the Canadian dollar.