Near-Term Setback in Canada May Offer a New Buy Opportunity

Since early April, the Canadian dollar has been the best performing currency, gaining about 14% against the US dollar. The Canadian dollar's rise is a function of higher commodity prices, narrowing of interest premium offered by the US (Dec Canada BAs vs Dec Eurodollars), and the preliminary signs that the global economic crisis may be easing.

The Bank of Canada meets on Thurs, 4 June. With high confidence, the BOC is most likely to leave the key rate at 25 bp. The BOC does not seem poised to engage in quantitative easing. If it does announce some version of QE, it would take the market by surprise and could force out the late longs. The net speculative position at the IMM swung from short Canadian dollars, as it has been since last July, to long Canadian dollars in early May. The latest CFTC figures show that the next longs more than doubled in the week through last Tuesday. The price action since suggests that speculators probably are even longer now.

Shortly after the BOC meeting, the IVEY PMI will be released. The consensus expects the continued recovery of the PMI. It bottomed in January around 36.1 and in April stood at 53.7. A small rise will put it near its 2-year average (54.8). The 10-year average is just above 57. Most manufacturing PMIs for the G10 countries remains at levels consistent with modest economic contraction or best stagnation. Canada is an exception and illustrates not just a turn of second derivatives, but first. It shows why many economists see Canada as leveraged to growth.

On June 5 Canada reports its employment data. The nearly 36k rise in April seem premature. The risk is that those job gains are reversed in full. Weakness in manufacturing may be particular pronounced.

Canadian officials have been fairly circumspect about the rise in the Canadian dollar, at least up until now. Using PPI or CPI to calculate purchasing power parity, the Canadian dollar appears to be 8.5%-9.5% rich. Usually this is not seen as a significant misalignment. However, should there be any sign of a double dip in the US economy ("W" bottom or an "L" bottom), Canadian officials may grow more concerned.

In immediate term, the US dollar has found support in the CAD1.0785-CAD1.08 area. The initial dollar bounce in North America saw CAD1.0880. A move toward CAD1.09-CAD1.0950 would provide a lower risk entry for new US dollar shorts.