A growing chorus of currency watchers is betting the mighty Canadian dollar CAD/USD-I is set to recapture the even mark with its suffering U.S. counterpart. After all, resource-rich Canada has what the world needs as the global recovery strengthens, dollar proponents argue.
But the loonie's swift ascent has some sober-minded analysts taking a hard look at the fundamental backdrop, and concluding the high-flying currency's real worth is something well below its current level.
Though rising prices for oil, copper and other commodities have boosted the Canadian dollar, they only justify a loonie at a little over 90 cents (U.S.), even with expectations of possible higher interest rates factored in, said Export Development Canada director of economics Stuart Bergman. The gap between that and its current level represents “an awfully big speculative wedge,” he says.
The Canadian dollar climbed more than half a cent to 97.05 cents Monday, a day ahead of a Bank of Canada announcement that will likely see interest rates stay on hold, and has risen 17 per cent in the past six months.
Currency traders have priced in a rapid economic recovery, Mr. Bergman said. “However, when the market gets real about fundamental growth beyond what's being boosted by stimulus measures, I think we'll see a retrenchment in oil, base metals and rate movement expectations,” he says. That puts the loonie even lower, in the mid-80 cent range, he adds.
It's difficult to untangle speculation from fundamentals because so many factors influence a currency's level, from mergers and monetary policy to politics and investor sentiment.
But some currency watchers say speculators have undoubtedly contributed to the recent surge.
Hedge funds betting on currencies have helped overvalue the loonie by about 20 per cent, said Canadian Auto Workers economist Jim Stanford. A record trade deficit in Canada should be scaring investors off, he points out. Instead, “fleeting bets” are driving the currency.
Even people in the thick of the market acknowledge the loonie has reached lofty levels. “The Canadian dollar does look very rich relative to standard valuation metrics,” said Gabriel De Kock, New York-based senior currency strategist at JPMorgan Chase & Co.
Still, Canada has weathered the recession better than most. And after global investors parked their money in cash for much of the past year, they're pouring back into markets, including higher-risk currencies and some say the momentum will last.
Watching the torrent of new money, “I'm not going to get in front of the Canadian dollar here,” said Mr. De Kock. “This still may still have some way to run.”
The loonie isn't the only currency to take flight lately amid U.S. dollar weakness, noted Sacha Tihanyi, Scotia Capital currency strategist. “To put it in perspective, you have to look at all currencies – and we're in line” with other commodity-based countries, he said.
Volatile currency markets are posing a challenge for forecasters, including the Bank of Canada. The central bank's current projections for economic growth rest on the assumption the exchange rate will average 87 cents -- almost 10 cents below its level today.
The greenback, meantime, continues to face headwinds, which may spur further buying in the Canadian currency.
Investors will likely see “downward pressure on the [U.S.] dollar for some time to come” as the allure of U.S. assets diminishes, said Richard Clarida, global strategic adviser at Pacific Investment Management Co., on the company's website Monday.
“While an orderly decline in the [U.S.] dollar is the most likely scenario going forward, a disorderly decline, while unlikely, cannot be ruled out.”
