Canada Dollar Rises From Almost 3-Year Low on Bets Rout Overdone

The Canadian dollar rose from almost the lowest point in more than three years on bets the currency had fallen too far, too fast after the Federal Reserve announced it would slow its monetary stimulus program.

Canada’s currency was still headed for a yearly decline against its U.S. peer as the Fed was set to allow borrowing costs rise when it begins reducing bond-buying in January. Both the Fed and the Bank of Canada are forecast to keep benchmark short-term interest rates unchanged through the second half of 2015, according to Bloomberg economist surveys. Speculators pared bets against the loonie from a seven-month high.

“We’re seeing some marginal recovery in the Canadian dollar, primarily on rebalancing and position squaring,” said Jack Spitz, managing director of foreign exchange at National Bank of Canada, by phone from Toronto. “One can make an argument that if risk continues to take a bid, then I think some of those drivers that we’ve seen a few years ago will likely come back into the forefront and could push the Canadian dollar stronger as a risk-related currency.”

The loonie, as the Canadian dollar is known for the image of the aquatic bird on the C$1 coin, rose 0.5 percent to C$1.0648 per U.S. dollar at 5 p.m. in Toronto after dropping to C$1.0728. The currency touched C$1.0738 on Dec. 20, the lowest since May 2010. One loonie buys 93.91 U.S. cents.

The loonie is down 7.3 percent versus the greenback this year, the biggest annual decline since 2008, while dropping 3.2 percent in the fourth quarter and 0.3 percent this month.

Investor ‘Rebalancing’

Canada’s dollar rose for the first time in three days as bearish bets against the currency by hedge funds and other speculators fell from the highest since the week of May 3 last week, figures from the Washington-based Commodity Futures Trading Commission show. The difference in the number of wagers on a decline compared with those on a gain -- net shorts -- was 58,432 on Dec. 24, compared with 65,500 a week earlier.

Those borrowing in Canadian dollars to fund investments in other currencies, a wager the loonie will decline, saw profit against 12 of the world’s major currencies this year, according to Bloomberg data.

“The market is rebalancing and lightening up on the U.S. dollar and putting money to work in the riskier currencies,” said David Watt, chief economist at the Canadian unit of HSBC Holdings Plc, by phone from Toronto. “We’re seeing people reassessing whether the tapering-induced rally in the U.S. dollar is sustainable or not -- and our view is, it wasn’t.”

Fed Taper

Central banks increased their reserve holdings in Canadian dollars by 2.4 percent to $112.5 billion in the third quarter of this year, according to data released today from the International Monetary Fund. Total foreign exchange reserves in all currencies the IMF tracks increased 1.9 percent last quarter, the data show.

The Fed said on Dec. 18 it will let long-term interest rates rise by cutting its monthly bond purchases in January to $75 billion from $85 billion. Policy makers will probably reduce bond purchases in $10 billion increments over the next seven meetings before ending the program in December 2014, economists said in a Bloomberg survey on Dec. 19. Higher U.S. interest rates make the U.S. dollar more attractive to speculators than the loonie.

The cost to insure against declines in the loonie versus its U.S. peer touched the lowest in almost 12 months, with the three-month 25-delta risk-reversal rate dropping as low as 0.86 percent on an intraday basis, the lowest since January. The average this year is 1.25 percent. Risk reversals measure the premium on options contracts to sell Canadian dollars versus buying U.S. contracts that do the opposite.

Volatility Rises

Implied volatility for three-month options on the U.S. dollar against its Canadian peer rose to 6.8 percent, the highest in three weeks. The measure is used to set option prices and gauge the expected pace of currency swings. The 2013 average is 6.7 percent.

The loonie is down 4.4 percent this year against nine developed nation currencies tracked by the Bloomberg Correlation Weighted Index. The yen has posted the biggest decline, with a 17 percent drop, while the U.S. dollar added 3.4 percent.

“We’ve seen a little bit of selling of U.S., buying of Canadian, for month-end rebalancing,” said Blake Jespersen, managing director of foreign exchange at Bank of Montreal, by phone from Toronto. “I do expect the Canadian dollar to underperform the U.S. in the coming quarter. As the Fed starts to move more aggressively on their tapering, and their economy starts to outperform ours, I think their dollar will do the same.”

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