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January 15th 2010

Canadian Dollar Headed for Parity

Only a year ago, who could have conceived of such a possibility? At the time, the Canadian Dollar (aka Loonie) was in the doldrums, as a result of the credit crunch and concomitant collapse in commodity prices. In March, however, the Loonie began an extraordinary rally, and finished the year up 16%, almost perfectly offsetting the record decline that it suffered in 2008. As a result, the Loonie is now only pennies away from returning to parity.

The Loonie’s rise can be ascribed to a combination of fundamentals and speculation. On the fundamental side, a surge in the price of oil and other commodities has driven a recovery in the Canadian economy. Summarized one strategist, “The fundamentals in Canada are strong. Sentiment is bullish Canada, and on a relative basis, Canada should do very well with stronger commodity prices and ongoing U.S. economic recovery.” On the other hand, non-commodity exports remain sluggish, such the current account balance is currently in the red.

It’s obvious then that the gap between reality and expectation is being filled by speculation. Despite the fact that both short-term and long-term Canadian interest rates remain low, investors are pouring money into Canadian assets in the hopes that rates will soon rise. This speculation reached a fever pitch in October of 2009, when the Loonie spiked 6% in less than two weeks, following a modest Australian rate hike.

At that point, Canadian Central Bank governor Mark Carney was forced to firmly step in (previously he had effectively remained on the sidelines) by warning investors that he was in no hurry to lift rates, and that “he had ways of cooling the currency.” While analysts credit Carney’s jawboning with effecting a modest decline in the Loonie, it has since resumed its upward march, breaking through the technical barrier of 97.5 CAD/USD yesterday.

In the short-term, sheer momentum will almost surely carry the Loonie through parity with the Dollar. Analysts are divided on the timing, with some suggesting as soon as this month and others suggesting that later in the year is more likely. They should be careful, as there is an exuberance in the forex markets that I havn’t seen since right before Lehman Brothers collapsed- the event that many say signaled the beginning of the forex markets. In other words, investors are surely getting ahead of themselves, since commodities are well off of their 2008 highs, interest rates are down, Canadian economic growth is mediocre, Canada’s fiscal condition is weak, and it is operating a current account deficit.

For this reason, many analysts are already becoming bearish on the Loonie. “The loonie looks potentially more vulnerable on a number of crosses unless we see renewed upside momentum,” expressed a strategist from RBC Capital Markets. But noticed that she framed a continued rise in terms of momentum, rather than fundamentals. That’s tantamount to saying, Unless the Canadian Dollar continues to appreciate, it won’t continue to appreciate. If that’s not a tautology, I don’t know what is! But seriously, she has a point, which is that the Loonie is being driven purely by speculation at this point, in a trade that could soon come crashing down…after it hits parity.

Canadian Dollar versus commodities

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Posted by Adam Kritzer | in Canadian Dollar, Central Banks, News | 2 Comments »

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2 Comments of “Canadian Dollar Headed for Parity”

  1. anne-tips Says:

    Amazing blog, your articles are all very complete and informative.
    I have a question, my broker added new currency pairs, included nzd/cad. Can you give any advice on this pair? Is it worth trading? The spread is very low, only 2.5 that is also why I wanted to try it…
    Im not much experienced in forex so I would appreciate your help!

  2. Adam Kritzer Says:

    Anne,

    I can’t give you specific advice about the NZD/CAD as I don’t follow this particular cross. They are both commodity currencies, so one would expect them to trade close to each other over time. Still, there are plenty of smaller trends (i.e. oil versus commodities, and interest rate differentials ) which could create some opportunities for profit over a shorter time horizon (3-6 months).

    As for the spread, 2.5 pips strikes me as pretty low spread, so from a cost standpoint, you’re in pretty good shape.

    adam

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