The Canadian Dollar has reached a 13 ½ year high against the USD. The reason, you may have guessed, has a lot to do with oil. A recent report on Canada’s oil resources estimates Canada’s famous oil sands may be worth more than $1 trillion. And that is a conservative estimate. Since the price of oil seems likely to remain above $50 in the long run, Canadian oil producers have reevaluated the viability of certain oil fields, now concluding that oil can be profitably extracted and sold. At this point, it seems nothing short of a complete collapse in the price of oil could halt the momentous run of the Canadian Dollar. The Ottawa Sun reports:

“The study … showed the oil sands are going to significantly contribute to the GDP growth over the next 15 years. That refocused a lot of international accounts on the whole ‘Canada as a big oil producer story.

The Canadian economy has grown quicker than expected in the latter part of this year. This has raised fears of inflation arising in the economy. As a result experts now predict that the Bank of Canada will again be forced to raise interest rates, making this the third such increase inside of a year. According to a recent article the central bank will not likely curb increases until it hits the projected 4% target. Experts see the economy finally starting to show signs of responding to the slow down pressure via the increased rate as evidenced in the drastic turn in which are profiled in

Canada’s economy grew at 3.8% in 2005 Q3, marking its fastest quarter of growth in over a year. The Canadian economy has historically been driven by exports of commodities. In this latest quarter, however, retail sales data indicate consumers have started to pick up some of the slack in the economy. As a result, Canada’s Central Bank has hinted that it will further raise short term interest rates from the current level of 3%. Currency strategists will likely remain bullish on the Canadian Dollar, as longs as its economy continues to hum and the differential between Canadian and US interest rates continues to narrow. Bloomberg News reports:

Yields on interest-rate futures indicate traders expect the central bank will raise its benchmark rate a quarter percentage point…on Dec. 6 and Jan. 24. The yield on the March futures contract was 3.86 percent, about the highest this year.

Earlier this week, the Canadian government received a vote of no-confidence, effectively bringing an end to months of allegations that Canada’s ruling Liberal Party was corrupt. As a result, the Canadian Parliament will be dissolved, and a snap election will be held at the end of January. In the past, currency traders have responded to episodes of political uncertainty be selling that nation’s currency. In this case, however, the Canadian Dollar was virtually unaffected. Canada’s economy continues to outperform on the heels of strong exports and lofty commodity prices, and its Central Bank is set to hike interest rates again next week. Reuters reports:

“With underlying support for the loonie from developing M&A deals, the geopolitical risks are still seen as taking a backseat to positive flows and fundamentals,” said [a senior currency strategist.

Last week, political pundits feared the worst when it was announced the Canadian Parliament had received a vote of no-confidence, and snap elections would be held next month. Currency traders, however, have reacted with indifference, sending the Canadian Dollar (Loonie) towards a 14-year high against the USD. Canada’s economy has boomed this year, on the back of record high commodity prices and strong exports. As a result, the Bank of Canada will likely to begin monetary tightening next week, by raising interest rates to 3.25%. If the Bank fulfills investor expectations by continuing to hike rates in the following months, the Loonie may continue to soar. The Edmonton Journal reports:

“The employment picture is solid, GDP growth is better than the bank expected and the U.S. economy is still rolling. Some are beginning to wonder if the bank won’t soon pick up the pace of rate hikes.”

In the last three years, the Canadian Dollar has appreciated over 35% against the USD! Most of those gains, however, took place in 2003 and 2004, as the Loonie only appreciated 3.5% in 2005. Accordingly, many currency strategists believe 2006 will be a flat year for the Canadian currency, due to declining commodity prices and a stagnant economy. In fact, recent economic data suggest that these two variables are closely related, as Canada relies heavily on commodity exports to drive its economy. Nonetheless, 2006 should witness hikes in Canadian interest rates, which could draw inflows of foreign capital. In short, there are competing forces tugging at the Loonie, which could conceivably be pulled in either direction. CBC Business News reports:

The central bank has raised its trend-setting overnight interest rate three times in recent months, to 3.25 per cent, to keep inflation from taking off. Analysts have said the bank could push the key rate as high as four per cent in 2006.

In a national election held earlier this week, Canada’s Conservative movement, led by Stephen Harper, emerged as the winning party. Harper’s victory, according to many currency analysts, represents the best outcome, as Canada can now move past the corruption scandal which plagued the previous administration. The new administration may also implement certain structural reforms, so as to make Canada’s economy less dependent on natural resource exports. Meanwhile, Canada’s stock market continues to set records, and Canada’s Central Bank is moving to stem the interest rate differential between Canada and the rest of the developed world. CBC News reports:

“A Conservative majority is expected to generate a positive short-term reaction for the dollar, as some policy concerns will be partially alleviated.”

In the last month, the Canadian Dollar has soared to unbelievable heights, reaching a 28-year high against its neighbor to the South, the USD. Most economists, however, believe the Canadian Dollar is overvalued. In a recent Press Conference, the President of Canada’s Central Bank insisted the Canadian Dollar’s recent run was mostly a product of speculation and does not reflect economic fundamentals. Further, many analysts expect the currency to retreat 5-10% against the USD in the coming months. Reuters reports:

“Although (U.S. dollar versus Canada) has reached a new 28-year low of 91.12 U.S. cents, the daily technical studies have been lingering at oversold extremes.”

Since peaking at the end of May, the Canadian Dollar has declined by almost 4% against the USD. Will the Loonie recover and continue to move towards parity with the USD, as many analysts predicted, or will it move further towards a more stable long term value? Despite soaring commodity prices, the Canadian economy is not growing as fast as many economists had projected. As a result, the Central Bank of Canada is unlikely to raise interest rates at its next meeting, which means the interest rate differential between the US and Canada will probably continue to widen, and the Canadian Dollar will continue to sell-off. Bloomberg News reports:

One analyst opined, “Market players are eager to test the Canadian dollar weakness…the Canadian dollar will almost certainly fall back into favor later this year, but not before sustaining further losses.”

The role of Central Banks in forex markets has become a hotly debated topic, as banks around the world continuously to intervene to prevent their currencies from appreciating. Canada is one of the few countries that has not attempted to stifle a significant rise in its currency. By all accounts, Canada should be an obvious candidate for intervention, for a strong Canadian Dollar (“Loonie”) has punished its export-driven economy. Canadian leaders, however, argue that the appreciating Loonie has forced Canadian businesses to become more efficient, and thus, welcome a more expensive currency. It has pledged to stay out of currency markets and allow market forces to determine the value of the Loonie. Bloomberg News reports:

Canada, which buys more U.S. goods than any other country, suggested it will keep out of currency markets for another five years and warned other nations to follow suit or face a global slowdown from trade imbalances.

Canada currently had enough oil reserves to supply all US oil needs for the next three years. The only problem is that much of this oil is trapped in Canada’s oil sands, and it may be costly and difficult to extract. Once the oil starts to flow, however, Canada will likely become one of the world’s top 10 oil exporters, behind such powerhouses as Venezuela, Russia, Saudi Arabia, and Iran. The recent strength of Canada’s currency, the Loonie, can be almost entirely attributed to the high price of commodities, especially oil. It seems forex traders would benefit from studying a little geology.

Seasoned forex traders turn to one place when they want to know how other traders believe a given currency will perform in the near-term: futures prices. There are only a few components to futures prices, namely underlying price, time to maturity, and volatility. The first two factors are usually given, which means ‘implied volatility’ can easily be calculated, providing a proxy for how the markets expect a currency to perform over the life of the futures contract. Currently, volatility in Canadian Dollar futures is virtually zero, which means despite the Loonie’s lofty valuation, the markets expect it to remain range-bound for the time being. The Globe and Mail reports:

Volatility is never far away from the currency markets. Canada could see elections in Ottawa and in some provinces within a year, and the outlook for the U.S. economy remains uncertain.

Since peaking in July, the Canadian Dollar has declined by over 6% against the USD, finishing the year down for the first time in five years. While movements in currency markets are often difficult to dissect, the reason for the fall of the loonie are not difficult to discern: falling commodity prices. Over the last few years, the Canadian Dollar has moved in near tandem with global commodity prices. Commodities now account for over half of Canadian exports, a figure which may grow further as Canada fine tunes its technique for squeezing valuable oil out of its now famous tar sands. Bloomberg News reports:

“The time to buy the Canadian dollar is nearing.” The currency will gain strength from a fast-recovering U.S. economy and the lack of a benchmark interest rate cut from the Bank of Canada in 2007, Citigroup predicted.

nce reaching a 14-month low earlier this month, the Canadian Dollar has rebounded, thanks to data which indicate the Canadian economy is emerging from a mild recession. The currency was also helped by surging prices for commodities, which account for more than half of the country’s exports. As the summer draws closer, the currency will likely accelerate upwards, helped by predictably strong energy prices. In short, it seems the Canadian Dollar’s recent sluggishness is probably just a seasonal adjustment rather than a long-term correction. Bloomberg News reports:

“The agency didn’t see any need for revising either the growth, or job numbers, which is the Canadian dollar positive development.”

After a multi-year run-up against the USD, the Canadian Dollar has been relatively quiet of late, gradually inching up but mostly trading flat. Last week’s release of Canadian retail sales data, a relatively mundane economic indicator, jumpstarted the currency and sent it upwards against the USD. As a result, Canada’s Central Bank is mulling its first rate hike in over a year, directly aimed at controlling its currency. In the short term, however, higher interest rates would likely bring more capital to Canada. With a booming economy and stock market to match, the country has never been more attractive to investors. Commentators are once again whispering about USD-CAD parity (a 1:1 exchange rate), an event that up until a few years ago, most would have dismissed as impossible. The Star reports:

Canada’s buoyant dollar reflects not just a weakening U.S. currency but a booming economy that is benefiting from higher prices of crude oil and metals like copper and gold, prompting big takeovers in the mining industry from foreign companies.

Last week, the Canadian Dollar traded at 94 cents against the USD, its highest level in over 30 years. This event is even more unbelievable considering the Loonie’s all time low against the USD occurred less than five years ago, in 2002. Now, many analysts are cautiously optimistic that the Loonie will be trading at parity with the USD by year-end, and perhaps continue appreciating past that point. Rising natural resources prices and a strong economy may drive Canada’s Central Bank to raise interest rates, at the same time that its neighbor to the south is contemplating lower rates. However, not all analysts are quite so optimistic. The Associated Press reports:

But with an expected dampening in the industrial and manufacturing sector on its way, other analysts predict the Canadi

The Canadian Dollar is making a run at forex history, having reached a 30-year high against the USD this week. The currency has appreciated by over 50% since 2002, and is up 9.4% this year alone. The Loonie is surging on a combination of high commodity prices and attractive interest rates. It is no coincidence that the price of oil has more than tripled over the five year period that the Loonie also appreciated in value. In addition, the Bank of Canada is expected to raise interest rates two more times in the near-term which would bring its interest rate levels close to parity with US rates. The last time the Canadian currency, itself, stood at parity with the USD was in 1976. While it now seems inevitable that the currency will soon return to that marker, there are still hurdles that need to be cleared. Bloomberg News reports:

“A strengthening currency has started to adversely affect the country’s growth, especially the manufacturing sector, which may raise concern the BOC needs to keep rates on hold.”

Interest rates in Canada remained at 4.5 percent today, resulting in a gain for the Canadian dollar. A statement made by the Bank of Canada showed that the nation’s economy is doing better than expected. Amid credit problems from the neighboring US, it seems Canada remains somewhat unscathed. Forbes reports:

‘Canadian bank traders see little in the BoC minutes to suggest that future rate hikes are in the works, after today’s ‘no change’ decision,’ said Peter Wadkins at Thomson IFR Markets.

With its continued strong performance against its neighbor to the south, the Canadian Dollar is almost defying logic, having jumped to 99cents against the USD in a matter of days. In purchasing power parity terms, the Loony is already among the most
expensive in the world. However, achieving parity (i.e. an exchange rate of 1:1) has a psychological value that can’t be cast in economic terms. Plus, it doesn’t hurt that high commodity prices have helped Canada to maintain years of strong growth and become America’s largest trading partner in process. And after the Fed chopped 50 basis points off of the US Federal Funds Rate, the Canada-US interest rate differential is virtually non-existent. One commentator thinks a 1:1 exchange could provide a basis for more economic cooperation between the two nations. The Globe and Mail reports:

“Parity is a very normalized level. Our [US and Canada] economies have become so closely intertwined that I think down the road what you’re thinking about is more of a North American bloc.”

Over the last five years, the Canadian Dollar has slowly climbed to parity against the USD, finally reaching the mythical 1:1 exchange rate last week. Canadian shoppers and
American tourists have taken notice, gradually adjusting their behavior in accordance wit their changing purchasing power. For many Canadians, this has translated into more frequent shopping trips across the border, whether for gasoline or for clothing. For Americans, this has resulted in a decline in the number of tourists visiting Canada. It is also slowly redefining the US-Canada trade dynamic. However, as Canada has become the United States’ largest supplier of oil, it is likely Canada that will
benefit most in this relationship. The New York Times reports:

The weakness of the American dollar worries some Canadian investors as well as businesses that rely on American customers.

The Canadian Dollar, or Loonie, recently cleared a 47-year high against the US Dollar. Its next major milestone is crossing a level last seen in the late 19^th century! There are a few reasons for the Loonie’s continued strength, namely interest rate parity and economic strength. As a result of the Fed cutting rates for the second time in as many months, the Canadian benchmark interest rate is now equal to the American federal funds rate, both at 4.5%. In addition, record-breaking oil and commodity prices will ensure that Canada’s economy will expand further, perhaps as the same pace as its currency. Reuters reports:

If the U.S. Central bank signals another rate cut in December, or if it goes against expectations and chops rates by 50 basis points, it could pull the rug out from under an already unsteady U.S. dollar and clear the way for the Canadian currency to shoot higher.

Unnerved by the tremendous appreciation in its nation’s currency, Canada’s Parliament is officially mulling the possibility of pegging the Loonie to the USD. It’s unclear at what value the two currencies would be linked, perhaps at parity. However, in testifying before Parliament, the future leader of the Bank of Canada argued staunchly against such an exchange rate regime. Such a relationship, he warned, would cripple Canada’s ability to conduct monetary policy, independent of the US. So long as the Loonie remained fixed to the Dollar, Canada would be forced into mirroring US interest rate movements. Because of several fundamental differences in their respective economies, it seems unlikely that this policy will be implemented. The CanWest News Service reports:

"It would mean that, de facto, Canada would adopt U.S. monetary policy, despite the reality that the structures of our economies are very different and, as a consequence, often require different types of adjustments in response to global developments."

When making predictions for 2008, it is useful to put things in perspective by assessing predictions made at this time in 2007. With regard to the Canadian Dollar ("Loonie"), most analysts predicted a rise, but all dismissed the possibility of parity with the USD. Ultimately, the Loonie rose to 1.10 against the Dollar before ending the year just above parity. With this in mind, experts are predicting the Loonie will continue to appreciate in 2008, with forecasts ranging from modest to stellar. Some analysts believe the Loonie will continue to ride the wave of high commodity prices, while others expect the currency to benefit from a general weakness in the US Dollar. But if 2007 taught us anything, it’s that these predictions should be taken with a grain of salt. The CanWest News Service reports:

Gartman, who two years ago predicted the loonie would reach parity with the U.S. greenback, says the Canadian dollar is poised to rise even further, but on its own merits, and not because of a run on the greenback, which he suspects is already oversold on world exchange markets.

Last week, the Bank of Canada cut interest rates by 25 basis points, bringing its benchmark lending rate down to 4%. Fortunately for the Canadian Dollar, the rate cut paled in comparison to the 75 basis point move effected by America’s Federal Reserve Bank. While the Bank of Canada offered a hackneyed rationale of "keeping aggregate supply and demand in balance" for the change in monetary policy, there is still some surrounding haze since Canadian inflation is rising and economic growth is strong. The currency had slipped below parity against its American counterpart, but is now slowly crawling its way back. If commodity prices remain high, the currency will likely push back across that psychologically important barrier of 1:1 with the USD.

Over the last few years, commodity prices, equity values, and interest rate differentials all favored Canada. By no coincidence, the Loonie rallied to such an extent that it soon reached parity with the USD. The relationship between these trends and the Canadian Dollar seemed so cut-and-dried that few analysts paid attention to anything else. In the last couple months, however, these relationships seem to have suddenly dissolved. For example, as the price of oil has begun to rise again, the Loonie has unexpectedly lost value. Meanwhile, the inverse correlation between risk aversion and the Loonie has lost all validity, such that if the S&P 500 increases, the odds that the Canadian Dollar will also appreciate is essentially an even money bet. The Canadian Economic Press reports:

"The breakdown is still quiet tentative but it’s weakened in the last few sessions. For Canada in particular there isn’t one story in the market. We have several different stories going on at the same time."

Last week, the Bank of Canada lowered its benchmark interest rate by 50 basis points, to 3.50%. Though the move was widely anticipated by analysts, whose only uncertainty was whether the bank would cut 50 bps or 25 bps, investors nonetheless punished the Canadian Dollar. The reason cited by the Central Bank in its press release accompanying the rate cut was a sagging economy, due in part to a more expensive Loonie and the concomitant decline in exports. In addition, the Bank indicated that it will likely have to cut rates further over the next few months in order to avoid recession. In short, it doesn’t look like the Canadian Dollar will upstage its 17% rise in 2007. Bloomberg News reports:

The central bank "has some very dovish words for the Canadian economy. Retaining the full easing bias and saying the risks to growth are intensifying have caught investors’ attention.”

Ironically, the faltering US economy has induced the Dollar to appreciate against many of the world’s currencies. The reasoning is that countries whose economies are tied closely to the US will falter even more than the US during a recession. One of those countries is apparently Canada. As a result, the Bank of Canada has already moved to cut rates by 50 basis points in order to mitigate against a full-blown Canadian recession. All of the economic indicators are already pointing downwards and GDP growth is projected to be a paltry 1.8% in 2008. In addition, exports to Canada’s largest trade partner, the US, have sagged noticeably, such that its current account recently slipped into deficit for the first time in nearly a decade. The Bank of Canada is busy plotting strategy, with additional rate cuts in the offing. It looks like the monumental run of the Loonie has finally come to an end. Bloomberg News reports:

Canada’s dollar will probably remain within the range it has held since the start of the year because investors are still avoiding risk amid the unsettled U.S. economic outlook. It has traded within about 4 percent of parity with its U.S. counterpart, after surging last year as high as 17 percent.

In a recent article published in the Toronto Star, a Canadian columnist outlined five reasons why the Canadian economy is in trouble. Only a couple factors are unique to Canada, and several can be subsumed under the credit crunch, but the pessimists are sounding broad alarm bells. First on the list is the looming drop in prices for commodities, the cornerstone of Canada’s economy. Oil recently sank below $100/barrel, and gold dropped 5% in one day! In addition, China is threatening to curb demand in order to rein in inflation.

The second and third causes for concern are a decline in bank credit and loss of confidence, respectively. Neither of these factors are endemic to Canada, as banks around the world have suddenly developed an aversion to risk and have tightened lending accordingly. Next, corporate expansion (namely of American companies) is stalling; Home Depot and Proctor & Gamble have already announced a temporary hold on opening new stores in Canada. The final factor(s) are American consumers, which collectively spend $9 Trillion per year. The recent tightening of wallets could spell massive trouble for Canada, since some of its provincial economies are primarily driven by cross-border sales to Americans.

In short, the Canadian economy could actually contract in 2008. But perhaps the resulting decline in Canada’s currency, the loonie, would make Canadian exports comparatively more attractive and return the economy to firm footing in 2009.

The Bank of Canada has cut its benchmark lending rate by 50 basis points, to 3.0%. The move was widely expected by analysts, although some of them had forecast only a .25% cut. Last week, economic data confirmed a mild rate of inflation in Canada, giving the BOC a green light to ease monetary policy without having to worry about the effect on prices. Despite commodity prices that remain at stratospheric levels, Canada’s economy is sagging, due to the subprime crisis unfolding across the border. Some analysts have analogized Canada’s situation to the dilemma facing the European Central Bank, which is reluctant to cut interest rates for fear of stoking the fires of inflation. As a result, the Euro has surged 8.5% against the Dollar in the year-to-date, while the Canadian Dollar has fallen. If the BOC opts to cut rates further, the Dollar could retake some of the ground it lost last year. Marketwatch reports:

Against the Canadian dollar, the U.S. dollar is likely to hold support around par, gradually firming back toward C$1.03 ahead of the U.S. Federal Open Market Committee meeting on April 30.

Just a few weeks ago, the Central bank of Canada aggressively cut interest rates in order to slow the spread of the US economic downturn to Canada. Accordingly, investors were quite bearish on the Canadian Dollar. With the price of oil surging, however, the Loonie has regained some of its luster, inching back towards parity with the Dollar. If commodity prices remain at current levels, Canada may avoid an economic recession. Economists have scaled back expectations that the BOC will have to continue cutting interest rates. Nonetheless, the median investor expectation is for a sustained decline in the Loonie, perhaps to $1.08 by year end. Bloomberg News reports:

The loonie, as the currency is known because of the image of the bird on the one-dollar coin, has traded near parity with its U.S. counterpart this year after climbing 17 percent in 2007.

According to one index, commodity prices have risen 40% over the last twelve months. One would therefore expect the Canadian economy to be commensurately strong. According to the most current economic data, however, just the opposite is true. Wholesale manufacturing sales are down for the second straight quarter. Non-commodity exports are also trending downwards due to sustained economic weakness in the US, Canada’s most important trade partner. Continued strength in the Canadian Dollar is also to blame. In addition, Canadians are traveling abroad in greater numbers, while international visitors to Canada have dwindled to record lows. As a result, Canadian GDP is expected to fall close to 0% for the second quarter, significantly below the Central Bank’s goal of 1%. The Bank will likely respond with a series of rate cuts, perhaps totaling as much as 1%, intended to reduce buying pressure on the Loonie and ignite the economy. Canada.com reports:

"The loonie is rising, boosted by last week’s energy and resource powered rise in the trade surplus as well as a positive
interest rates spread."

The economic picture in Canada is increasingly resembling that of the rest of the world: slowing growth and rising inflation. Likewise, the dilemma faced by the Bank of Canada mirrors that of the ECB and Fed. Even though Canadian inflation is only 2.2%, the Bank of Canada will probably err on the side of caution, by hiking rates rather than lowering them. Then again, analysts don’t expect the Central Bank to take any action for another six to twelve months, based on the expectation that a cooling economy will naturally bring down inflation. That makes this whole debate seem moot, given how much could happen in such a long time frame. Canada.com reports:

Canadians will get a better idea of the central bank’s thinking when it releases its monetary policy update and governor Mark Carney opens himself up to public questioning at a news conference later on its rate-setting decision…

The Canadian Dollar continues to lose its luster. Falling natural resource prices and the credit crunch have combined to exact a devastating blow on the Canadian economy, causing it to actually contract in the most recent month for which data is available. Now, the Central Bank is predicting that the economy will expand by only 1% in 2008. Most economists expect that Canadian Monetary Policy will soon lag US policy, especially if the Fed raises interest rates to combat inflation. Based on these developments, the consensus is that the Canadian Loonie is significantly overvalued, and will lose some of its value over the next few years, falling to a more sustainable level against the US Dollar. Bloomberg News reports:

The loonie will slide to C$1.05 by the end of December, and to C$1.09 by the start of 2010, according to the median estimate of 31 strategists surveyed by Bloomberg.

Having fallen well below parity with the USD, the Canadian Loonie is now being attacked on two fronts. First, there is the deteriorating economic situation. Prices for virtually all commodities, namely oil, have declined significantly this year, dealing a harsh blow to the natural resource-dependent Canadian economy. In addition, its largest trade partner, the US, is suffering from economic woes of its own and is in no position to support the Canadian export sector. The result is surging unemployment and the most precipitous decline in factory production in 25 years. The most optimistic economists are forecasting GDP growth of 0.0% in 2009. The second prong of the attack against the Loonie is being waged unintentionally by the country's Prime Minister, who recently suspended Parliament in order to avoid a no-confidence vote in his leadership. In short, bulls for the Canadian Dollar (not to mention democracy) don't have much to be excited about these days. Bloomberg News reports:

"The global backdrop is bearish for the Canadian dollar and domestic numbers are merely piling on,"said a senior currency strategist. "No one is looking for reasons to buy the Canadian dollar right now. They want reasons to sell."

Read More: Canada's Dollar Posts Weekly Decline on Jobs, Politics, Oil

Despite an ebb in risk aversion, the Canadian Dollar is once again falling. Since touching a high of $1.18 in January, the Loonie has zigzagged its way downwards and hovered around $1.25. March 31 marked the end of its third straight quarterly decline.

With the exception of the Japanese Yen (which is declining due to economic factors), virtually every currency has risen against the US Dollar in recent weeks. Stock market rallies have been accompanied by a general pickup in risk tolerance, and investors are piling back into assets and currencies that had been abandoned during the worst of the credit crisis. Why, then, has the Canadian Dollar been excluded from this rally?

Investors cannot be faulted for focusing on the abysmal Canadian economic situation. Employment, public and private spending, and construction - to cite a few indicators - are all falling at alarming speed. As a result, “the nation’s economy, the world’s eighth largest, will shrink at an 8.5 percent annualized pace in the first quarter, the largest decline since at least 1961.” Given that the picture is equally grim throughout the world, however, there must be another explanation.

Cue Mark Carney, head of Canada’s Central Bank, who has announced that Canada will “adopt a much milder version of the U.S. and U.K. strategy of printing more money to fight the recession.” Euphemistically referred to as “quantitative easing,” such a policy involves the injection of cash directly into credit markets and government bond markets, with the dual purpose of creating liquidity and stimulating the economy.

The concern, especially among forex traders, is that printing money will lead to inflation further down the road. When similar policies were announced by the Central Banks of the US, UK, and Switzerland, for example, their currencies plummeted instantly. In the words of one trader, “The precedent is a haircut right off the currency.” The Central Bank of Canada does have a reputation for being conservative, which suggests that it is likely to pursue quantitative easing only as a last step, and in a measured dose.

Accordingly, there is still some bullish sentiment surrounding the Canadian Dollar. One analyst even urges readers to “Consider the Canadian Dollar as a Possible Inflation Hedge,” partly on the basis that “The Loonie is a commodity based currency, so stronger commodity prices mean a stronger Loonie.” Given that crude oil and base metals prices are extremely correlated with the Loonie, this is a fair point.

“Canada’s currency will fall 3.3 percent to C$1.27 to the U.S. dollar by July, from C$1.2298 on April 3, according to the median forecast in a Bloomberg News survey of 40 economists and analysts.” Whether this prediction actually obtains depends primarily on what, if anything, Mark Carney and his colleagues at the Central Bank of Canada decide at their next meeting, scheduled for April 23.

Today, the Bank of Canada followed up on an earlier promise by formally clarifying its position on quantitative easing. Suffice to say that the markets breathed a huge sigh of relief when it was revealed that the BOC was not committing itself to such a program. ” ‘The market has always had great trepidation about the idea of printing money…As the Bank of Canada has pushed back at that notion, the Canadian dollar is having a little party of its own,’ ” quipped one analyst.

In other words, the BOC would like to avoid following in the footsteps of its counterparts in the US, UK, Japan, and perhaps the EU, by pumping newly-minted money directly into credit and government bind markets. At the same time, the Bank admitted that a rapid deterioration in the Canadian economy would certainly prompt it to reconsider. Governor Mark Carney et al have approached the subject of quantitative easing coyly. On the one hand, today’s report (as well as the BOC website) contain detailed explanations of what quantitative easing would hypothetically entail. On the other hand, they insist that such a scenario does not fit with their economic projections, and hence remains unlikely. “The need to do extraordinary easing is a ‘big if,’ ” in the words of Governor Carney.

This is largely consistent with analysts’ expectations, one of whom had predicted that “it’s also quite possible the bank could simply lay out a framework on Thursday and not take any action at all.” Even ignoring the inflationary implications of quantitative easing, it’s not clear whether such a policy could even be effective. “The corporate bond market is reviving, with spreads narrowing and issuance levels improving, raising the question of whether central bank involvement is necessary or appropriate in a market that seems to be healing itself.” Granted, most investors are now wearing their rose-tinted glasses, but the data speaks for itself.

The BOC’s estimation that it can avoid quantitative easing is somewhat dubious, since it is predicated on overly optimistic economic forecasts, as well as because it has already exhausted the primary tool in its monetary arsenal. Earlier this week, it lowered interested rates to a record low of .25%, capping a 16-month period of easing, during which it slashed rates by 4.25%. By the Bank’s own reckoning, interest rates will remain low until mid-2010, as inflation is now comfortably within the target range of 1-3%.

Given the abysmal economic situation, it is no surprise that inflation has moderated. Commodity prices are well below the record highs of 2008. Aggregate demand, and GDP by extension, are retreating in kind. According to one economist, ” ‘When you do that math, no matter how optimistic you are, you are talking about a time frame of years before things like the unemployment rate (are) back down to historically normal levels.’ ”

Still, traders remain bullish on the Loonie. “Since March 9, the loonie has climbed 6.2 percent…The loonie will appreciate to C$1.19 by the end of March next year, according to the median forecast of 38 economists and analysts in a Bloomberg survey.” As the Forex Blog reported in yesterday’s post, the carry trade has returned, which is good news for commodity currencies, low interest rates are not. Meanwhile, low interest rates could stimulate corporate borrowing and home buying. Given the Central Bank’s reluctance to print money, the economic recovery would even unfold without the drag of inflation. Maybe the excitement is justified…