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Canada's 'policy credibility' will help drive the loonie

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Dollar closes at par The Canadian dollar closed out the day at a buck even. No decimal points. Bang on par with its U.S. counterpart.

The loonie has been gaining as the U.S. dollar weakens, but has also been boosted by higher commodity prices and other factors.

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"Unlike its major trading partner, Canada has oodles of policy credibility which will prove [Canadian dollar]positive, against [the U.S. dollar]and against other major currencies, particularly during periods of increased turbulence that seem sure to recur given the enormity of forthcoming adjustments," RBC Dominion Securities strategists said before the official close.

"... Policy credibility and other [Canadian dollar]positive factors on the horizon suggest that the peak in Canada's effective exchange rates are not out of reach in the future."

Can commodity prices be sustained? There are growing questions about the spectacular run-up in commodity prices, though they were generally down today. Capital Economics, for one, wonders whether they won't be the first bubbles to burst among the various asset prices, which have surged since the Federal Reserve announced its latest $600-billion (U.S.) quantitative easing program.

"Overall, the financial markets may indeed be in danger of running ahead of themselves," chief international economist Julian Jessop said in a research report today.

"One way in which this could unwind is that the surge in commodity prices chokes off demand for those products, sooner or later, leading to a sharp correction that reverberates through riskier assets of all types."

Global stock values have climbed at a pace 10 times that of the money the U.S. central bank plans to pump into the system, he noted, though the "euphoria" may soon ebb.

"We suspect that the first asset class to cause problems for the global economy, and perhaps the first bubbles to burst, will be commodities."

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The run-up has come primarily in industrial metals and agriculture, Mr. Jessop said, noting that "households typically have little choice than to pay higher prices for essentials such as food and energy (and builders have to buy copper), so prices can be driven well above levels that could be sustained once supply and demand have had more time to adjust."

He also noted the softness in the Baltic Dry Index, which tracks shipping.

"The weakness of the BDI may partly reflect an increase in the supply of shipping, as well as the lower price of fuel compared to the 2008 peaks," he said, but it also could be a warning sign that "final demand for commodities may be nowhere near as strong as their prices in financial markets would suggest."

Is RBC on 'too big to fail' list? Royal Bank of Canada is on an original list of global banks deemed too big to fail by regulators, The Financial Times reports today.

The Financial Stability Board, which has for months been working on such a list for the G20, put RBC and other banking giants such as Goldman Sachs Group Inc., JPMorgan Chase & Co, Citigroup Inc., Credit Suisse and Nomura in the document of institutions whose collapse would put the global financial system at risk, the newspaper said.

The G20 is working on creating two lists, one with the global banks whose failures would pose international risks, the other of institutions whose collapse would be trouble in their home countries.

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In Seoul, where the G20 begins meeting tomorrow, Finance Minister Jim Flaherty denied the report, telling Globe and Mail correspondent Kevin Carmichael that it is "something that surfaced a couple of months ago and remains inaccurate."

Mr. Flaherty also said that he's not in favour of pegging some banks as too big to fail, and that officials will continue to struggle with the question.

He said leaders will discuss how to ensure taxpayers never again pay the bill for financial institutions that are "too big to fail," but that divisions remain too great to expect a breakthrough.

"There's more work to be done," Mr. Flaherty said in an interview. "I'm not actually a big fan of 'too big to fail.' Personally I'm not. I think all financial institutions need to be regulated and supervised properly."

Citing the newspaper report, Desjardins analyst Michael Goldberg said the impact of such a move would be negative.

"Looking at the list, it seems to us that the common thread regarding whether banks are included or not included - what makes them exceptional - may be the relative scale of their trading activities," Mr. Goldberg said.

"Royal Bank is the only Canadian bank on this purported list and what makes it exceptional vs. its peers is that its trading revenue (adjusted to exclude markdowns) has typically been at least double the level of other major Canadian banks ... If the scale of trading activity is the key yardstick for inclusion on this list, then less trading activity may be seen as the route to getting off the list. But less trading activity would also mean a lower contribution to earnings from this activity and concern about what actions Royal might take to be removed from this list may lead to negative reaction from the stock."

Shoppers beats forecasts Despite profit-pinching drug reforms, Shoppers Drug Mart Corp. managed to beat analysts' forecasts for its third quarter results.

Nevertheless, the new generic drug changes did squeeze Shoppers' third-quarter bottom line in the third quarter - the first period in which the impact of the new Ontario legislation showed up for the country's largest drug-store chain, Globe and Mail reporter Marina Strauss writes.

For the 16 weeks ended Oct. 9, profit fell to $159-million or 73 cents a share from $171-million or 79 cents a share. Sales rose 2.6 per cent to $3.093-billion. Excluding a charge of $10-million (pre-tax) to settle a legal dispute, profit in the latest quarter was $167-million or 77 cents a share.

"Shoppers appears on track to attain the high end of its 2010 [earnings per share]forecast range of $2.66 to $2.72," said Desjardins analyst Keith Howlett. "Management expects to be able to grow [earnings per share]in 2011 from the level it achieves in 2010."

China trade data to heighten tension China's blowout trade numbers are certain to raise the temperature as leaders of the G20 begin meeting in Seoul tomorrow. It's this very issue - global imbalances and currency reform - that has raised tensions in the run-up to the discussions.

Official data released today showed that growth in exports slowed slightly in October - but slow for China still meant a 22.9-per-cent surge - while imports rose 25.3 per cent. That left China with a surplus of $27.15-billion (U.S.), a marked increase from the $16.88-billion registered in September.

The numbers come amid heightened tensions over imbalances in trade and currencies. China, in particular, has been under constant pressure from the United States and other countries to allow its yuan to appreciate. Adding fuel to that fire are today's numbers from China showing it exported $25-billion in goods to the United States last while, in return for U.S. imports valued at just $5-billion. This will set the stage for a "tense" G20 summit, noted Mark Williams, senior China economist at Capital Economics in London.

"China's delegation to this week's G20 summit will have a hard job convincing others that China's government is doing all it can to stimulate domestic spending," Mr. Williams said.

"Concern about the export outlook will not be accepted as a reason to move slowly on the renminbi. In dollar terms, China's exports are now 8 per cent higher than they were two years ago, when the financial crisis hit. Global exports overall are still some way below that level.

"... The last five months' surpluses with the U.S. were the five largest on record. All in all, these data will bolster the case of those at the G20 and elsewhere arguing that China should be doing more to stimulate domestic demand."

Behind the trade numbers The United States and trade irritants aside, there was some good news in the Beijing data for resource-based economies such as Canada, and the world economy in general as China remains a global engine of the recovery.

"The strong import data are consistent with other activity indicators showing that China has had only a moderate slowdown in recent months, with domestic demand still solid," said Brian Jackson of RBC Dominion Securities.

"High commodity prices are also clearly playing a major role," Mr. Jackson added, citing the fact that imports of key resources, including oil, copper and iron ore, have seen "mixed growth" in terms of volume, but are up sharply in terms of value.

"Imports from major commodity suppliers - including Australia, Canada and Russia - also showed stronger year-over-year growth in October," he said.

U.S. deficit narrows The United States also reported trade numbers today, but for September. While the numbers are better than expected, they're not likely to change the debate.

The deficit narrowed in September to $44-billion, and the deficit with China narrowed to $27.8-billion, still almost a record high and almost $6-billion fatter than where it stood a year ago.

The shrinking overall deficit is likely partly due to the softening of the U.S. dollar, noted Toronto-Dominion Bank economist Christos Shiamptanis.

So, what you have are two sets of data from two different countries for two separate months.

"September's U.S. trade figures make good reading for Chinese officials travelling to Seoul for tomorrow's G20 summit, but there is still a clear incentive for the U.S. to push for measures that put pressure on China to devalue the renminbi and stimulate domestic demand," said Paul Dales, U.S. economist at Capital Economics in Toronto.

Canada's deficit widens Canada's trade deficit neared a record in September as exports of goods such as cars and medicine declined, particularly to the U.S.

The deficit widened more than expected to $2.49-billion in the month from $1.49-billion in August, Statistics Canada said today. Exports tumbled 1.7 per cent on lower volumes while imports rose 1.2 per cent, and have been relatively flat all year.

The trade picture weakened as demand from Canada's largest trading partner remains tepid, The Globe and Mail's Tavia Grant reports. Exports to the U.S. fell 3.6 per cent to their lowest level since last November.

"While export growth is expected to remain soft, domestic demand has downshifted significantly which will be reflected in weak import growth," said Toronto-Dominion Bank economist Diana Petramala. " As such, we look for a slight improvement in the trade balance (but to remain in deficit territory) in coming months - but not for the right reasons."

China hikes bank reserves At the same time, according to reports from Beijing, China boosted its reserve requirements for the country's major banks by half a percentage point. This comes amid mounting concerns over so-called hot money flooding into China and other emerging markets, particularly in the aftermath of the Federal Reserve's new quantitative easing program.

"This move further highlights that Beijing's policy focus has shifted decisvely from concerns about domestic growth and external demand to concerns about inflation pressures and liquidity management," RBC Dominion Securities economists said in a research note.

"Further monetary tightening will be needed over the coming months and we look for at least [half a percentage point]of interest rate hikes during the coming year."

Zoellick says policy makers must watch gold World Bank President Robert Zoellick expanded on his comments on gold today, saying in a television interview that policy makers must pay attention to the fact that markets are treating gold as a monetary alternative.

Earlier this week, Mr. Zoellick proposed a new monetary system that would focus heavily on several currencies, including the U.S. dollar, the euro, yen, pound and yuan, also known as the renminbi. Gold would be used as a reference point for market expectations.

But surging gold prices show that some investors are using bullion as an alternative.

"Gold is the yellow elephant in the room," Mr. Zoellick told Bloomberg Television. "Markets are already using gold as an alternative monetary asset because confidence is low. Policy makers need to consider this as an indicator about how markets are viewing their policies."

Speaking at a conference, he also said that policy makers are ignoring this fact as they struggle over global imbalances.

CIBC sees lower dollar Fears that the Federal Reserve is drowning the global economy in U.S. dollars are overblown and that means that commodities and the Canadian dollar are likely to pull back, according to CIBC World Markets chief economist Avery Shenfeld.

In a new report, Mr. Shenfeld predicts that the Canadian dollar will fall to 93 cents by March and remain there through June.

The economist, often ranked as one of the most accurate, says that while there are lots of dollars being given to banks, they are not spreading into the wider market, The Globe and Mail's Boyd Erman reports today.

CPPIB rebounds The Canada Pension Plan saw its fortunes rebound in the quarter ended Sept. 30, posting a 6.6 per cent investment return after losing 1.3 per cent in the first quarter.

Assets climbed by $8.9-billion in the fiscal second quarter to $138.6 billion, with $8.4-billion of the gain coming from investment returns and $500-million coming from new member contributions to the fund.

The Canada Pension Plan Investment Board said the stronger quarter was largely attributable to the strong performance of global equity markets, The Globe and Mail's Janet McFarland reports today.

GM posts hefty profit General Motors Co. is setting a strong stage for its coming initial public offering.

GM today posted a third-quarter profit of $2-billion (U.S.), or $1.20 a share, a turnaround from a loss a year earlier after GM came out of bankruptcy protection. It's now on track for its first annual profit since 2004, and it has bested the earnings of its two Detroit rivals.

The IPO is expected later this month.

Foreign buying of bonds carries risks A new report today raises the prospect of Canadian investors being squeezed out by a rush of foreign buyers to Canadian bonds.

"Never before has the country ridden such a wave of foreign investor interest," Warren Lovely, the government finance expert at CIBC World Markets, writes in a research note titled "It's getting crowded in here."

This, he said, is creating potential risks in the market.

In the past, Mr. Lovely said, net foreign direct investment accounted for a more modest share of inflows. That has changed.

"More than foreign takeovers of Canadian firms, purchases of Canadian securities - more precisely net buying of bonds - define the current era of foreign investment," he said.

"As a share of GDP, net purchases of Canadian bonds are at an all-time high, equivalent to 7 per cent of GDP during the past four-quarter period, or four times the long-run average."

With the recession, there had been fears that a surge in government government might force out private investment, but that didn't happen.

"But could this foreign buying spawn a new style of crowding out, displacing some domestic investors by driving yields and spreads to artifical and unattractive levels?" Mr. Lovely wrote.

In the past year, half of all bonds issued in Canada were swallowed by foreigners, and in the first half of this year alone almost two-thirds.

There are clear benefits to this shift overseas, Mr. Lovely said, but he warned, too, of the risks.

"In sufficient size, non-resident investment flows risk overheating the market, particularly as government funding needs begin to ease. For many foreign investors, Canada is not necessarily a core market. As such, a rotation away from Canada could force a rapid withdrawal, adding potential volatility to financial markets."

Many of the concerns will likely be "well managed," however, and the troubles of other countries are likely to keep foreign interest in Canada high.

Still, for now "the single biggest concern may very well be there simply aren't enough Canadian bonds to go around."

From today's Report on Business

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About the Author
Report on Business News Editor

Michael Babad is a Report on Business editor and co-author of three business books. He has been with Report on Business for several years, and has also been a reporter and editor at The Toronto Star, The Financial Post and United Press International. His articles have appeared in major newspapers around the world. More

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