3/22/2010
If the Canadian dollar doesn’t make it up to parity against the U.S. dollar now, it will do so later.
In fact, there is a good chance the U.S. currency will sink as far as CAD0.95, a level it last traded at back in 2007.
The reasons for the continued strength of the Canadian dollar are quite simple. As a commodity-driven economy, Canada is emerging from recession faster than the U.S. and its interest rates will start rising well before those of its southern neighbor.
The only thing holding the Canadian dollar back at the moment is the timing of the rate hikes.
The U.S. dollar’s decline from way up at nearly CAD1.28 at the start of 2009 has effectively tightened Canadian monetary policy already and ensured that inflation pressures have remained subdued.
As a result, the Canadian money markets, which are now pricing in as much as 140 basis points of rate hikes over the next 12 months, may have got ahead of themselves and recent strong support for the Canadian currency could well lose some of its momentum.
It could also be argued that the last time parity was in the Canadian dollar’s sights, the price of crude oil was surging and a boom in merger and acquisition activity ensured heavy inflows into Canada.
This time around, crude prices are stable and M&A activity is, if anything, going the other way.
Nonetheless, the outlook for the Canadian economy remains strong as the economic recovery in Asia is helping to ensure good demand for the country’s commodity exports.
If anything, economic growth could actually pick up, eventually providing the inflation pressures that will force the Bank of Canada into moving on rates well before the U.S. Federal Reserve in Washington launches its rate-hiking cycle.
“We think there are clear risks to the upside thanks to booming house prices, creeping wage pressures and increasingly buoyant consumer confidence,” said the strategy team at Societe Generale.
The importance of the housing market was already evident in January retail sales data released on Friday, that showed a surprisingly large 0.7% rise, helped in part by increased sale of building materials.
Also new consumer price index data, showing that core inflation rose 0.7%, rather than just 0.3% as expected, contributed to concerns about rising price pressures and the eventual need for rate hikes.
So, while the Canadian dollar may well lose some of its upward momentum as parity looms into view, it will only be a matter of time before the currency finds itself being propelled through that level and beyond as a widening yield differential with the U.S. kicks in.
Early Monday in Europe, the U.S. currency was up a little at CAD1.0173 by 0745 GMT from CAD1.0155 late Friday in New York, according to EBS.
The dollar was getting support as the euro came under pressure again after German Chancellor Angela Merkel made it clear at the weekend there is still no bailout package for Greece and warned against creating “false expectations” that an agreement will be reached at this Thursday’s European Union summit.
Market sentiment had already been undermined by Friday’s surprise rate hike in India, which raised fears that more emerging markets will tighten policy.
Trading levels have been subdued as Japan is on holiday.