Canadian Dollar Tracking its Commodity Compatriots to its Detriment

The Canadian dollar was battered this past week - and not just against its benchmark US counterpart. Despite lacking some of the most vital statistics of a carry currency; the loonie has long enjoyed an ill-deserved association to the high-yielding Australian and New Zealand dollar. However, just as surely as the Canadian unit enjoyed the benefits of its alliance; it will also suffer from the short-falls. This leverages a lot of what happens to the loonie this week and beyond on the pace and direction of underlying risk appetite; but this really isn’t a unique situation as most of the market is traveling the same road. However, a distinctive bond to the US dollar as well as a monetary policy position in flux can certainly complicate things.
In the week ahead, Canadian dollar traders will follow first and foremost general risk trends. Though this currency’s benchmark lending rates are near zero (its market-based yields aren’t much better) and the economy’s recovery is still a work in progress; it has enjoyed all the tangible benefits of a carry currency like the Australian or New Zealand dollar. Where is this link made? Primarily through commodities. As investor optimism and economic growth have recovered this year, capital has sought out those securities with a potential for leveraged appreciation and some level of security (just in case). Clearly, commodities have the characteristics to attract even the most cautious of investors: after peaking at record highs a few years ago, there was clearly lots of room to run; a blatant economic recovery meant true demand; and then there was always the detail that these natural resources are tangible. This is a good example that fundamental strength in the currency market is relative. However, it is also the case that this trait will remain as surely through a correction in risk appetite as during its ascent. If we see a significant shift in risk appetite, the Canadian dollar will lose much of its underserved strength.Aside from risk appetite, the assessment of the loonie’s fundamental strength lies in the same big ticket items (growth, interest rates, monetary policy) that every other currency responds to. Measuring up to its more risk-fit Australian and New Zealand counterparts, the outlook for interest rates is looking stable at its extraordinary lows. This past week, BoC Governor Carney reiterated his intention to maintain rates at 0.25 percent as long as inflation cooperated. Backing the policy authority up, the OECD recommended in its semi-annual economic assessment that the bank keep rates near zero until June of next year and perhaps longer. The market sees little chance that the currency will jump ahead on the yield curve anytime soon as there is no probability of a hike at the December 12th meeting and interest rate swaps are pricing in only 56 basis points worth of tightening over the next 12 months. Perhaps more influential is the deliberation on growth. The OECD offered a moderate assessment of economic activity by saying a recovery began in the summer and was gaining momentum; but the jobless rate would continue to rise into 2010, tempering expansion in the process. Carney was more bearish when he said it was too early to call a recovery and said a currency that was stronger than what fundamentals supported was undermining a more prolific revival.