The Canadian Dollar (“Loonie”) recorded a fairly strong 2010. It appreciated 5.5% against the US Dollar, as an encore to a 16% gain in 2009. Moreover, its rise occurred with remarkably little volatility, fluctuating within a tight range of $0.99 – $1.08 (CAD/USD. It total, it rose against “seven of its major peers,” and “gained 4.4 percent over the past year in a measure of 10 developed-nation currencies, Bloomberg Correlation-Weighted Currency Indexes showed.” As for 2011, it is expected to continue trading close to 1:1 against the USD, though analysts differ over which side of parity it will tend towards.
At the moment, there are a few key fundamental trends driving the Loonie. As the WSJ encapsulated, the first factor is investor risk tolerance: “The fortunes of the risk-sensitive Canadian dollar in 2011 will be determined in large part by the issues driving global market fluctuations.” Due primarily to the EU sovereign debt crisis, risk appetite continues to experience dramatic ebbs and flows. Based on conventional wisdom, risk averse investors should incline towards shunning the Loonie in favor of the US Dollar and other safe haven currencies. However, if you track the Loonie’s actual performance, you can see that concerns over global financial instability have hardly impacted it. Thus, bulls see this uncertainty as a force that “pushes investors to diversify their foreign exchange holdings by picking up some Canadian dollars.”
The second set of factors are macroeconomic. While slowing slightly in the second half of the year, the Canadian economy nonetheless exhibited a solid performance, which is expected to continue into 2011. Goldman Sachs, for example, “now sees growth accelerating to 3.3 per cent in the second quarter of this year, and 3.5 per cent in both the third and fourth quarters amid improving domestic demand.” However, the strong performance by natural resources and Canadian export strength that drove growth in 2010 could also be interpreted as a wild card in 2011, as the trade surplus narrows from a moderation in commodities prices and an expensive Canadian Dollar.
Finally, there is the continuing search for “value currencies” that is driving investors towards the Loonie. According to Bill Gross, manager of the world’s biggest bond fund, “It’s a critical strategy going forward to get…into some currency that holds its value…I’d suggest Mexico, Brazil or Canada as three examples of countries with good fiscal balance sheets.” It doesn’t hurt that the Bank of Canada was the first G7 central bank to raise interest rates, and that its benchmark interest rate compares favorably with the US Dollar, Yen, etc. Moreover, it is forecast to hike rates by an additional 50 basis points in 2011, beginning in the third quarter. On the other hand, it will still be a couple years before rates are high enough to make carry trading viable. Besides, long-term interest rates are currently higher in the US, which means that investors hungry for yield will ultimately have to find other reasons for shifting funds to Canada.