Loonie 5-Year Low Looms on Corporate-Debt Flow, UBS Says

The Canadian dollar may weaken to a five-year low as slow economic growth and rising U.S. interest rates spark a retreat from the country’s corporate debt similar to that seen in government bonds, according to UBS AG.

“If the Federal Reserve raises rates, then money will go back into the U.S.,” Geoffrey Yu, a senior currency strategist at UBS in London, said in a telephone interview. “That’s bad for the Canadian dollar.”

The currency could weaken more than five cents to C$1.15 per U.S. dollar over the next year as stronger U.S. growth prompts the Fed to increase record-low borrowing costs, Yu said. With higher interest rates available in the U.S., the relative yield advantage of Canadian corporate debt will disappear, eliminating a capital flow that’s supported the currency amid an exodus from the country’s government debt, he said.

“Most of the buyers of Canadian debt are actually U.S. investors,” Yu said. “If the dollar strengthens, then U.S. investors are going to move back into the U.S. and they’re going to sell their Canadian assets.”

Canada’s dollar, known as the loonie for the image of the waterfowl on the C$1 coin, last touched C$1.15 in July 2009. It traded at C$1.0946 today in Toronto.

The Fed has held its main interest rate at zero to 0.25 percent since 2008 to support the economy. Traders see about a 50 percent chance policy makers will raise it to at least 0.5 percent by July 2015, based on futures contracts.

Shifting Portfolios

With yields on Canadian government debt touching their lowest in a year last week, foreign investors have looked to shift their Canadian portfolios into higher-yielding instruments such as company debt. Statistics Canada reported yesterday the biggest monthly divestment of government debt on record in June, while foreigners added to their holdings of Canadian corporate bonds for a fifth straight month.

Yu said he sees the relative allure of Canadian corporate bonds as short-lived, with rates set to rise in the U.S. and Canadian growth still sluggish. He points to weak job growth and slow productivity gains as signs the Canadian economy isn’t getting the same boost from U.S. growth it has in the past and will need the currency to weaken further to help.

“Why do you buy corporate bonds?” Yu said. “You expect the economy to do well, you expect people to spend and you expect corporate revenues to increase. That isn’t happening because growth isn’t happening.”

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