pofme.com Canadian Dollar and Parity
Posted by POFME.com on April 23rd, 2010
Canadian Dollar and Parity
The Canadian Dollar’s performance of late has
been eerily redolent of its sudden rise in 2007,
when propelled by nothing more than sheer
momentum, it rose 20% against the Dollar and
breached the parity mark (1:1) en route to a
30-year high. [Of course, we all remember what
happened next: the credit crisis struck, and the
Loonie plummeted even faster than it had risen].
Last week, the Canadian Dollar breached parity
again, and after a brief retreat, it touched parity
again today. On the one hand, this latest rise was
simply a matter of making up for the ground lost in
2008, when risk-averse investors shifted capital en
masse to the US. On the other hand, Canadian
fundamentals are fairly strong, and that the Loonie
is once again at parity is deservedly so.
Last week’s
jobs report was pretty solid, but the Canadian
unemployment rate is still high, at 8.2%, mirroring
the “jobless recovery” phenomenon in the US.
According to the Bank of Canada’s own estimates, GDP
growth is projected at a healthy 3.7% for 2010,
thanks to a strong recovery in oil and commodity
prices. As a result, the
Bank of Canada has finally given the indication
that it is ready to hike interest rates, perhaps as
soon as July. After concluding its monthly meeting
yesterday, it noted, “With recent improvements in
the economic outlook, the need for such
extraordinary policy is now passing, and it is
appropriate to begin to lessen the degree of
monetary stimulus.”
On the other hand, one has to wonder how long the
momentum in the Canadian Dollar can continue. While
Canada’s economic recovery has indeed been strong,
it is no more impressive than the recovery in the
US. (In fact, it should be noted that the two
economies remain deeply intertwined). In addition,
the (Canadian) economy is already expected to slow
down slightly in 2011 (3.1%), and slow further in
2012 (1.7%), which makes me wonder whether the Bank
of Canada will have to tighten slightly in order to
achieve its inflation objectives. Moreover, while
the BOC will probably hike rates slightly before the
Fed, the arc of monetary policy followed by the two
Central Banks will probably be pretty similar for
the next few years, regardless of what happens.
This means that interest rate differentials between
the two economies should remain pretty close to the
current level (near 0%), and won’t expand enough to
make a CAD/USD carry trading strategy viable.
It seems the
futures markets concur, as the Canadian Dollar
is projected to hover around parity with the USD for
the bulk of the next 12 months. Granted, futures
prices have pretty closely mirrored the Canadian
Dollar’s performance in the spot market, but the
point is that investors seem to expect the CAD/USD
exchange rate to settle down for a while.
Remarked
one analyst, “The Canadian dollar parity party
is in full swing, however further Canadian gains
will be at a much slower pace as the existing long
Canadian positions get trimmed on profit taking in
the absence of new bullish Canadian catalysts.”
Incidentally, this is exactly what the Bank of
Canada wants, and spent the better part of 2009
trying to convey to forex markets. If the Loonie
were to rise further, it could threaten the economic
recovery, and at the very least, the BOC would
proba1bly hold off on hiking rates.
In the end, 1:1 does seem like a reasonable
exchange rate. I haven’t seen any economic models
that argue one way or the other, but it certainly
makes sense from the standpoint of convenience and
market psychology. Barring any unforeseen
developments, I don’t see it fluctuating very much
in the short-term, one way or the other.
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