Sunday, January 6, 2008

Canadian Dollars Prove Too Good to Be True as Bears Bite Back

By Liz Capo McCormick and Haris Anwar

Jan. 7 (Bloomberg) -- Just when Canada and its mighty dollar appeared to be eclipsing the U.S. as the beneficiary of world-beating fiscal surpluses, burgeoning energy resources and global demand for commodities, the struggling American economy is biting back with a vengeance.

The loonie, so-called because of the national bird on the one-dollar coin, rose more against the U.S. dollar than the currencies of any other Group of 10 nation, surging 17 percent in 2007 as the price of crude oil rose 57 percent.

Such foreign exchange skyriding proved fleeting as exporters increasingly starved on their shrinking loonie- denominated revenue. Canada's trade surplus tumbled 40 percent between last January and October. Retail sales rose 0.1 percent in October and fell in four of the first 10 months last year, Statistics Canada said.

All of which suggests ``the Canadian dollar will weaken in the first half of this year, considering the massive exposure through trade that its economy has with the U.S.,'' said Stephen Jen, the London-based head of currency research at Morgan Stanley. ``As the U.S. slows, there will be interest to sell the Canadian dollar.''

The loonie's sobering outlook comes only three months after it traded one-for-one with the U.S. dollar for the first time in three decades. Canadians were so impressed they insisted the country's economy had finally decoupled from the U.S., in a world short of the energy, grains and metals Canada supplies in abundance. The loonie rallied even as growth of its biggest trading partner, the U.S., slowed to an annualized gross domestic product of 1 percent last quarter, according to the median estimate of 63 economists surveyed by Bloomberg.

Too Good

Now foreign exchange traders say it was too good to be true. The currency tumbled 11 percent to C$1.0029 per U.S. dollar, after reaching 90.58 Canadian cents, the highest since 1950, on Nov. 7. It will weaken 5.6 percent to C$1.06 this year, the biggest drop since 2001, according to a Bloomberg survey of 43 analysts.

``Everything is terrible now in Canada, from manufacturing to retail sales to tourism to exports,'' said John Taylor, who oversees about $12 billion in currencies as head of New York- based FX Concepts Inc. and was bullish as recently as September. ``The U.S. will probably go into recession, or at least slow down, and that is going to hurt Canada.''

The loonie weakened 2 percent last week, the most in six weeks. Speculators led by hedge funds are exiting bets on a rally, futures trading shows. They held a net 22,998 futures wagering on gains as of Jan. 1, down from a record 83,001 in October, according to the Washington, D.C.-based Commodity Futures Trading Commission.

`Hit Quite Hard'

The trade surplus dropped to C$2.81 billion in September, the smallest since 1998, from last year's high of C$5.78 billion in May. The government may say Jan. 11 that the balance fell to C$3.2 billion in November from C$3.32 billion the previous month, according to the median estimate of 16 economists surveyed by Bloomberg.

``We're seeing plenty of signs that the Canadian economy will ease this year,'' said Stephen Poloz, chief economist in Ottawa at Export Development Canada, the nation's main export credit agency. ``The trade sector is getting hit quite hard.''

Canada may grow more slowly than the U.S., according to Bloomberg surveys published Dec. 11. The economy will expand 2 percent in 2008, compared with 2.3 percent in the U.S., according to the median forecasts. In 2007, Canada probably grew 2.5 percent and the U.S., 2.2 percent, the surveys show.

`Badge of Confidence'

Signs of decline are increasing as the U.S. faces its worst housing slump in 27 years. The U.S., with an economy and population about nine times as large, buys about 80 percent of Canada's exports.

Business and government spending fell in December to a six-year low, with the Ivey purchasing managers' index dropping to 45.9. The index, derived from 175 managers surveyed monthly by the Ivey School of Business in London, Ontario, was 58.7 in November. Readings below 50 mean purchasing contracted.

Frank McKenna, deputy chairman of Toronto-Dominion Bank, the country's second-biggest lender, and a former ambassador to Washington, said in September that the rise to parity was ``a badge of confidence in our country.''

With oil reaching a record $100.09 a barrel on Jan. 3, Stephen Malyon, a currency strategist in Toronto at Scotia Capital Inc., said he hasn't given up on the loonie. He forecasts it will reach 96 Canadian cents per U.S. dollar by yearend.

``We expect that crude oil prices will stabilize and stay at high levels,'' averaging $88 a barrel this year, said Malyon. ``This will keep people demanding commodity-linked currencies like the Canadian dollar.''

Higher Yields

Scotia, a unit of the country's third-biggest bank, expects one quarter-percentage point rate cut by the Bank of Canada, to 4 percent this quarter. The firm forecasts the Federal Reserve will drop its 4.25 percent target rate for overnight loans between banks to 3.75 percent by April and to 3.5 percent by June 30. The ``interest-rate spreads still very much favor the Canadian dollar,'' Malyon said.

Two-year Canadian bonds yield 3.55 percent, 80 basis points, or 0.80 percentage point, more than comparable-maturity Treasuries. The gap is the widest in four years.

The currency's advance contributed to the loss of more than 6,500 jobs in the country's wood and forest products industry in the first nine months, the Forest Products Association of Canada said Nov. 22. Companies announced 54 permanent or indefinite mill closures, according to the Ottawa-based association.

Morgan Stanley's Call

Strategists at New York-based Morgan Stanley made the bet that the loonie will fall against the U.S. dollar their top currency recommendation for 2008. In the past month, Paris-based Calyon, Deutsche Bank AG in Frankfurt, Lehman Brothers Holdings Inc. of New York and Toronto-based RBC Capital Markets also predicted in research reports that the Canadian dollar will slide.

In the five U.S. recessions going back to 1973, Canada's gross domestic product also contracted for at least one quarter.

``I'm not a believer in the decoupling theory,'' said Adam Boyton, a senior strategist in New York at Deutsche Bank, which predicts the currency will weaken to C$1.1 per U.S. dollar this year. ``The Canadian dollar is very responsive to developments in the U.S.''

The Institute for Supply Management's manufacturing index fell to 47.7 from 50.8 in November, the Tempe, Arizona-based group said Jan. 2. U.S. payrolls rose by 18,000 last month, the least since August 2003, while the jobless rate reached a two- year high of 5 percent, government data showed on Jan. 4.

`More Difficult Year'

Bank of Canada Governor David Dodge said in an interview on Canada's Business News Network last week that an economic slowdown may be ``warranted'' because companies won't be able to meet demand without raising prices.

It will be ``a much more difficult year for the Canadian dollar,'' said Mitul Kotecha, head of global currency strategy for Calyon, the investment banking arm of Paris-based Credit Agricole SA, France's second-largest bank by assets. ``There is a lot of disappointment in store for the Canadian dollar bulls.''

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