Not Much Canada Can Do About Soaring Loonie

The Canadian dollar hit a low near 77 cents in early March and with today's advance, briefly moved above 97 cents. Since the March low the Canadian dollar has appreciated by more than 25%, which is nearly 3 times the yen's advance and 50% more than the euro's advance in the same period.

Last week, Canada reported its largest trade deficit on record. The Aug shortfall of CAD2 bln was more than twice deficit that the consensus expected. Through August, Canada has reported an average monthly trade deficit of CAD0.54 bln this year compared with an average monthly surplus of CAD5.2 bln in the same year ago period.

Canadian officials have jawboned a bit, noting that the strength of the Canadian dollar would hamper the recovery, but with little lasting impact. Many investors are asking if the Bank of Canada will intervene.

It seems highly unlikely. Even if the ideological hurdle was overcome, the odds of success seem sufficiently low as to make it highly improbable. First, it is not simply a case of Canadian dollar strength, but broad based US dollar weakness. Second, the latest surge in the Loonie seemed to have been sparked by fundamental news--a disappointing US jobs report and a better than expected Canadian employment report (Canada created 30k jobs, almost 6-times greater than the consensus forecast, with the unemployment rate falling to 8.4% from 8.7%). Third, the US dollar's weakness is seen largely as a function of its low interest rates in relative and absolute terms.

One of the few things that would embolden speculators more than no intervention is a failed operation. Non-commercials (speculators) at the IMM nearly doubled their net long Canadian dollar futures positions in the week ending on Oct 6 to 35.7k, it is still off from extreme readings, such as the 50k hit near the middle of 2008 and the record 83k in mid-Oct 07 (the Canadian dollar's recent high was set in Nov 07 near $1.04).

Market positioning is not at an extreme, the US dollar's decline is broad-based, but orderly and seemingly fundamentally driven. Even if intervention then can be discounted, what about quantitative easing ? Couldn't the Bank of Canada offset the tightening of monetary conditions induced by the strength of the Canadian dollar ?

While this has been threatened, it appears that conditions have to deteriorate substantially more to get officials over the operational hurdles. A number of countries are engaged in QE in some fashion, but the effect on money supply and bank lending has under-whelming.

A local paper argues that the BOC may have to hike rates sooner than its pledge (not to raise rates until at least the middle of next year) on ideas that house prices may be bubbling. This might be a bit of an exaggeration. New house prices for Aug were reported earlier today. The 0.1% increase was a little less than expected and follows a 0.3% gain in July. Q3 may be the first quarter since Q3 08 that new house prices in Canada may increase.

Bottom line: Canada's policy options seem limited to mostly jawboning at the present. Stronger growth in the US is the best thing for Canadian exports. Canadian officials can not be sure intervention of quantitative easing would arrest the Canadian dollar's rally or boost money supply and lending. There seems little to be done by marking time until a Fed rate hike. That said the Canadian dollar is trading more than 2 standard deviations from its 20-day moving average. In such conditions, two things tend to happen. The Canadian dollar tends to stabilize, even if briefly, and the 20-day moving average drifts toward currency (more so than the other way around).