Canadian Dollar Setback

Falling commodity prices amid general position adjustment in the foreign exchange market is weighing on the Canadian dollar today. The Loonie is trading at its lowest level since late March. The near-term risk seems to extend toward CAD1.03, but the underlying favorable fundamentals remain intact.

On top of the softer commodity story and unwinding of positions in the currency market, the volcanic ash that has shut airports in Europe is beginning to impact the east coast of Canada. Specifically, the main airport in Newfoundland has already begun cancelling some flights.

Canada did report that foreign investors bought slightly less Canadian assets in Feb than had been expected, while Canadians themselves stepped up purchases of foreign assets. Non-residents bought C$6.7 bln of mostly Canadian bonds. They were buyers of Canadian bonds for the 14th consecutive month. Half of the flows went into Canadian government bonds, and the remaining half was roughly divided equally between corporates and provincial issues.

Canadian's bought C$1.8 bln of foreign bonds, mostly US Treasuries (2/3) and the remainder corporate US bonds and some non-US bonds. Canadians bought about C$1.4 bln of foreign equities, mostly non-US. Canadian purchases of foreign assets in Feb was the highest in about a year.

The fundamental case for the Canadian dollar remains intact. It is predicated on current interest rate differentials and the likelihood that the Bank of Canada hikes rates in the June/July period, before the other G7 countries.

The Bank of Canada meets tomorrow. No one expects a rate hike of course, but the guidance from the central bank is awaited. Given the recent string of somewhat softer than expected data, the risk is that the BOC's statement encourages expectations of a July rate hike than June.

Specifically, employment, housing starts, senior loan officer survey, and manufacturing sales all came in below expectations this month.

Looking forward, CPI and retail sales are the economic highlight of the week. The pace of inflation may moderate slightly and retail sales excluding autos cannot sustain the 1.8% pace seen in Jan. The consensus calls for less than 1/4 of that pace.

Speculators at the IMM marginally extended their long positions in the ending last Tuesday. Since then the US dollar bottomed near CAD0.9950. It would not be surprising to see more momentum traders throw in the towel and look for better levels to buy the Loonie again. We suspect potential exists toward CAD1.03. Support now is pegged near CAD1.0120.