Loonie Gains Haven Status With Only G-10 Tightening Forecast
Canada’s dollar is turning into a haven for foreign-exchange investors shunning European turmoil and seeking the safety of the U.S. without the budget deficits or political gridlock.
The currency, which underperformed nine major peers in Bloomberg Correlation-Weighted Indexes in the first eight months of the year, has rebounded, topping all except the U.S. dollar and yen since. As the U.S. struggles with a $1.3 trillion budget shortfall, AAA rated Canada may use rising commodity revenue and spending cuts to balance the budget within five years.
Bank of Canada Governor Mark Carney will be the only central bank leader in the Group of 10 countries to raise interest rates next year, according to forecasts compiled by Bloomberg News. Inflation has exceeded the bank’s 2 percent target for 11 months as the economy grows at double the pace of the Group of Seven nations. Canada’s six largest banks say the so-called loonie will gain versus the dollar even as the U.S. economy strengthens.
“There’s a North American story right now that is potentially very powerful,” David Watt, a senior currency strategist in Toronto at Royal Bank of Canada, the nation’s largest lender, said in a Nov. 28 telephone interview. If “you want less exposure to financial uncertainty and less exposure to sovereign risk, then Canada has got a number of beneficial features,” he said.
The loonie, known for the aquatic bird’s image on the dollar coin, will appreciate to parity with the greenback by the end of next year, Watt said. Toronto-Dominion Bank, the country’s second-largest lender, sees it rallying to 95 cents per U.S. dollar by then after weakening to C$1.09 in the first quarter. Bank of Nova Scotia, the third-largest, predicts it will strengthen to 98 cents.
Canada’s dollar closed at C$1.0195 versus the greenback on Dec. 2 in Toronto, capping its biggest weekly gain since October. It was at C$1.0156 at 8:09 a.m. in New York. While the currency has lost 2.9 percent since the start of the year, the most among 10 currencies tracked in Bloomberg Correlation Weighted Indexes, it’s up 2.1 percent in the past three months. Only the U.S. dollar, up 5.5 percent and the yen, 2.1 percent higher, have strengthened more.
“Despite external headwinds, the Canadian economy has shown a fair amount of resilience, underpinned as it is by a stable and healthy banking sector and solid fiscal position” Robert Sinche, global head of currency strategy at Royal Bank of Scotland Plc’s securities unit in Stamford, Connecticut, and another analyst at the company, Farrukh Khan, wrote in a Nov. 29 research report.
They recommend buying the Canadian dollar versus the euro and forecast it will strengthen to C$1.28 per euro from C$1.36521 last week. European leaders will meet this week to discuss ways to curb the region’s growing debt crisis, which has seen bailouts of Greece, Ireland and Portugal and now threatens to engulf Italy and Spain.
Options traders are becoming less bearish. The one-month so-called 25-delta risk reversal rate, which measures the premium charged for the right to buy the U.S. dollar in one month against the loonie over contracts to sell, ended Dec. 2 at 2.27 percentage points, the lowest closing level since September, from 3.15 percentage points the week before. The rate slid to as low as 2.1 percentage points today, the least since Sept. 21 on an intraday basis.
Outpacing G-7 Growth
Canada’s economy is growing at 3 percent, twice the average pace of Group of Seven and euro-area nations. Finance Minister Jim Flaherty pledged his Conservative Party government will eliminate the budget deficit, forecast at C$31 billion this fiscal year, by 2015. The U.S. deficit is $1.3 trillion, or 9.6 percent of output. Canada’s budget deficit is 4.3 percent of output.
Banks in Canada were named the soundest for a fourth year by the World Economic Forum. RBC, TD, Scotia and CIBC reported last week that fourth-quarter profit rose an average 43 percent. The companies didn’t require bailouts during the 2008 financial crisis and weren’t among the global banks downgraded by Standard & Poor’s on Nov. 29.
Carney will raise the Bank of Canada’s policy rate by 25 basis points in the fourth quarter next year to 1.25 percent, according to the weighted average of 21 forecasts compiled by Bloomberg News.
Rates on Hold
The Federal Reserve has pledged to keep rates unchanged until at least the middle of 2013. The European Central Bank will cut rates next quarter, while the Bank of England, the Swiss National Bank and the Bank of Japan will stay on hold through 2012, economists surveyed by Bloomberg predict.
Concern the U.S. economy would sink into a recession made the loonie the worst-performing G-10 currency after the U.S. dollar since the middle of 2010.
“Sentiment had turned so incredibly bearish on the U.S. economy that the potential for more positive surprises going forward will help the Canadian dollar,” said Camilla Sutton, head of currency strategy at Bank of Nova Scotia’s Scotia Capital in Toronto, in a Dec. 1 telephone interview.
Canada’s currency shouldn’t be considered a haven because of its relationship to U.S. stocks, according to Shaun Osborne, chief currency strategist at Toronto-Dominion Bank’s TD Securities unit.
The 30-day so-called correlation coefficient between the Standard & Poor’s 500 Index and the Canadian currency reached 0.9221 on Nov. 30, the highest in Bloomberg records dating to 1992. A reading of 1 indicates the measures move in lockstep.
“It can’t really be considered to be a safe haven in terms of somewhere to go in times of uncertainty because in times of uncertainty it tends to underperform, which is not what a safe haven is supposed to do,” Osborne said in a Nov. 28 telephone interview. “The Canadian dollar is still very much attached to risk assets.”
An improving U.S. economy, destination for about 70 percent of Canada’s output, would boost demand for its raw materials, which account for about half the country’s export revenue.
The U.S. added 120,000 jobs last month and the unemployment rate fell to the lowest in more than two years, according to a Dec. 2 Labor Department report. The Institute for Supply Management-Chicago Inc.’s business barometer increased to 62.6 in November from 58.4 the previous month as orders and production strengthened.
Canada has the biggest proven crude oil reserves after Saudi Arabia and Venezuela, according to BP Plc. It’s the world’s second-largest producer of uranium after Kazakhstan, the third-biggest producer of natural gas and the third-largest exporter of wheat.
The loonie is likely to beat commodity-linked counterparts such as the Australian and New Zealand dollars next year because growth is slowing in Europe and China, according to Royal Bank of Scotland’s Sinche and Khan.
China’s economy, the world’s second largest, will slow to 8.5 percent next year, from 9.2 percent in 2011, the median estimate of 15 economists in a Bloomberg survey show. The country accounts for 25 percent of Australia’s exports, with Asia taking more than 70 percent, according to the Reserve Bank of Australia.
“While recent bouts of risk aversion have weighed on the Canadian dollar, the growth divergence that is underway between the euro zone and North America is likely to favor the Canadian dollar in coming weeks and months,” Khan and Sinche wrote in the Nov. 29 report to clients.
Traditional havens have been undermined by central bank intervention. The Swiss National Bank has pegged the maximum franc rate at 1.20 per euro, while Japan’s estimated 8 trillion yen intervention knocked the currency down more than 4.5 percent against the dollar during intraday trading on Oct. 31.
“Canada represents a commodity proxy, a stable government and a stable banking industry,” said Jack Spitz, managing director of foreign exchange at National Bank of Canada in Toronto, the country’s sixth-largest bank, in a Nov. 30 telephone interview. “As America goes, so Canada goes.”
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