Category — Canadian Dollar

The surprising rally of the US Dollar this week has inevitably led to what seems like everyone and their niece predicting just how long it will last. My 10-year old niece doesn’t like the dollar, and though she’s a very bright girl, please note that she based her reasoning on the Canadian dollar looking a lot cooler than its American counterpart. Given that for several years the USD has done little but suffer, it’s of little surprise that few people are giving the greenback a chance.

Predicting the future can be a tricky business, so it’s important to follow some upcoming events that could determine the USD’s long term prospects. Some people throw caution to the winds regarding the future, such as Doc Brown, “Roads? Where were going, we don’t need roads.” In the world of Foreign Exchange, however, should you find yourself without a Flux Capacitor, it is very important to look at these events. They have guided currencies for as long as the market has existed.

In the short term, the upcoming G8 meeting could set the tone for the USD’s future. Should the USD become a focal point at the meetings (as it is expected to), one possible outcome would be a new dedication to strengthen the USD. There is a history of nations working to correct currency weaknesses, such as the Plaza Accord. However, while that agreement was aimed at the US facilitating the recover of the Japanese Yen, the tides have now turned.

Two more reasons for foreign countries to aid the USD are that commodities (such as oil!) are generally priced in dollars, and that the many countries holding dollar reserves would love to see those reserves have higher value. However, the results of the G8 will not be the only piece in shaping the USD’s future. The most important factor rests in the hands of Chairman Bernanke, and whether or not he can walk the walk as much as he has talked the talk regarding interest rate hikes.

Upcoming Figures

CHF Adjusted Real Retail Sales (Apr)

EUR Euro-Zone Consumer Price Index (May)

USD Net Long-term TIC Flows (Apr)

USD Total Net TIC Flows (Apr)

JPY Tertiary Industry Index (Apr)

Inflation has always been an important concern for currency analysts, if only because it has a direct relationship with interest rates.  Central banks have a mandate to keep inflation under control, and so signs of rising inflation indicate a strong currency.  But the new paradigm of an increasingly international economy could leave monetary policy makers impotent in the face of global inflationary surges.

Commodity prices are near record highs, and interest rates do not have the power to completely moderate supply-side inflationary pressures.  Oil is selling for almost $80/bbl, and there are market analysts who believe we are likely to see $100 oil by 2008.  That would put oil at the $100 level one full year before Goldman’s now infamous oil projections of last year.  Gold and food prices are also through the roof (they are the primary driver of high prices in Australia and New Zealand).  With growing demand for commodities from developing economies, price pressures are not in line to let up anytime soon.  In the forex market, the most prominent consequence of the commodity boom is the incredible rise of the three major commodity currencies (Canadian dollar, Australian dollar and New Zealand dollar).

But more troubling for fans of domestic monetary policy is that inflation is also being stoked by rising prices for finished goods and services.  This phenomenon has surprised many observers because it seems counterintuitive to the idea of globalization.  Free trade was supposed to lead to higher efficiency and lower prices.  But with emerging markets all over the world on the rise, we are seeing more and more wealth in the developing world.  A booming economy naturally leads to higher prices, and the Chinese yuan, Indian rupee and other emerging market currencies have appreciated significantly this year.  Goods from these countries are now more expensive, and so as we buy imports from the rest of the world, we see China and India and Brazil exporting inflation.

Growing wealth in the world’s developing areas has other consequences of inflation as well.  Rich foreigners buy assets in the developed economies, and more buyers drives up the price of these assets.  This is partly the cause of exploding real estate prices in London.  For those concerned about the US dollar, we should note that the weak dollar makes US assets especially attractive.  It is as if US products were being sold at a discount relative to prices in the past.  This is why foreign ownership of US securities reached record levels last May.  But forex traders should still keep track of the current state of the US dollar.  Traders like to invest in markets that are growing (and economies that are healthy.  So while a weak dollar might be good for the US economy, a weakening dollar is bad.  And with central banks less powerful in the face of the new global economy, we might not be able to do anything about it.

Commodity currencies have been beating up on the US dollar and the Japanese yen recently and yesterday was no different.  The Canadian dollar, the New Zealand dollar and the Australian dollar all hit new highs, an occurrence so common in that last couple of weeks that’s most traders simply yawned.  Some of the underlying support for these currencies comes from high commodity prices, especially oil and gold, of course.  But much of the gains should also be attributed to weakness in the US dollar and the yen carry trade.

It is pretty easy to spot the strength the commodity currencies have derived from greenback bears.  The data released in the respective countries has not been really great.  Canada’s inflation numbers yesterday printed lower than expected.  Australia and New Zealand have not released much data recently, and what has been released has been worse than expected.   But the rise of the Loonie, Aussie and Kiwi cannot be stopped.  And that can be traced back to the sluggishness of the US dollar.  And the market consensus after Fed Chairman Bernanke’s speech is that US interest rates are likely to stay the same for some time.  Bernanke also seemed more concerned about the slumping housing market than he has been in earlier speeches.  And so the commodity currencies should continue to benefit from the weak dollar.

The other factor fueling the fresh highs in this area of the forex market is the yen-based carry trade.  The interest rate advantage for Australia and New Zealand compared to Japan is enormous, and currency traders just cannot seem to get away from the high yields.  And that differential is likely to get higher as the futures market lists a 66% probability that the Reserve Bank of New Zealand will raise the country’s interest rates, already the highest in the industrialized world, at its next meeting.  Most currency analysts are pricing in another rate hike this year for the Royal Bank of Australia as well.

The appetite for risk (as well as the hunger for yield) in the market is tremendous, and the surging carry trade is reflective of that.  AUD/USD is at an 18-year high and NZD/USD is at its highest level since the currency was floated in 1985.  While the amazing rate of appreciation might be hurting the country’s exporters, the situation is only exacerbated by the weak greenback.  It is because of this phenomenon that the Canadian dollar is up 12% already this year, with the USD/CAD hitting 1.0416 this morning, its highest level since 1977.  But the latter pressure is not likely to go away anytime soon as many analysts are touting the weak US dollar as good for the American economy.

You might have been expecting Patrick to talk about this one (he loves Canada), but he’s a little busy with China right.  So you got me.  The Bank of Canada raised its benchmark interest rate this morning to 4.50%, and the forex market…well the forex market basically yawned.  The USD/CAD pair did retract somewhat from the 30-year low hit yesterday, but the growth did not amount to much.  The loonie is still in a position of strength, and some currency analysts are even talking about parity in the USD/CAD.

Much of the recent growth in the Canadian dollar can be attributed to the international bull market for commodities.  Commodities make up just about half of Canada’s exports.  The price of oil just came down from its 10-month high, but it is still above $70/bbl.  That is especially significant because there is an amazing 85% correlation between the price of oil and the value of the loonie with relation to the greenback.  The prices of copper and gold are also on the ascent, and that is going to provide further support for the loonie.

But the story of the Canadian dollar cannot be explained only by commodity prices.  Wages are up a phenomenal 3.5% this year.  Core inflation, subtracting energy and food prices, was at 2.2% in May, an improvement over the 2.5% level in April, but still above the 2% target set by the central bank.  This allows the bank some leeway to raise interest rates again this year.  The appreciation of the Canadian dollar hurts exporters to some degree (and the world’s ninth-largest economy is still primarily driven by exports), but policy makers in Ottawa believe that a stronger currency might do more good than harm.

Basically, the bank is not going to let USD/CAD approach 1.000.  The central bank will intervene in the forex market before that happens.  But with the pair trading at a little above 1.05 now, do not be surprised to see levels of 1.04 soon.  Some currency traders and analysts have already priced in two more rate hikes by next March.  And they might not be far off, considering the following statement accompanied the interest rate announcement this morning: “some modest further increase in the overnight rate may be required to bring inflation back to target over the medium term.”  For right now, I would bet on the Canadian dollar and be careful when I am on a submarine (dolphins apparently like to watch).

Reports in Canada showed unexpected zero economic growth for the month of April, the Canadian dollar came crashing down from a 30-year high. The Canadian currency dropped to 94.16 U.S. cents from yesterday’s 94.39. The zero growth report comes as a big surprise, for there had been a 0.3 percent increase in March. Investors have been betting on Canada’s Central Bank to increase interest rates in the attempt to lower the persistent inflation. A higher interest rate would mean an increase in value for the Canadian dollar. However, investors with long positions have been caught off guard as the Central Bank is very unlikely to raise interest rates as previously expected. Instead, interest rates are likely to go down in the attempt to reboot the economy.