Canada Update

The US dollar fell to 4-year lows against the Canadian dollar late last month near CAD0.94. In the tumultuous markets in the first half of August, the US dollar rallied about 6.5% into August 9th to briefly poke through CAD1.0 for the first time since early Feb. With today's weakness, the US dollar has surrendered a little more than a third of its rise.

There is scope for additional dollar losses against its Canadian counterpart. While the CAD0.9700 area draws immediate attention, there is potential toward CAD0.9640 in the coming days.

This constructive view of the Canadian dollar is partly predicated on the return of greater stability to the equity markets in general and the US S&P 500 in particular. Using 30 and 60 day rolling correlations on percentage change, the correlation between the Canadian dollar and S&P 500 is making new highs for the year today just below 0.9.

Meanwhile, it is interesting to note that the correlation, conducted on the same basis with WTI is slipping below 0.5 on both the 30 and 60 day time frame. The clear, even if simple take away is that in the current environment equities are more important to the Canadian dollar than oil.

In addition to oil and equity prices there are two other forces that often appear to help influence the Canadian dollar. Interest rates differentials and expectations and foreign demand for Canadian assets. There has been a shift in market expectations toward the Bank of Canada. Between July 21 and last week the implied yield of Canada's Dec BA futures fell 80 bp. The market has not only removed the hike it previously was leaning toward and now is pricing in the odds of a rate cut.

Canada's 2-year note has outperformed the US 2-year note over the past 1 and 3 months. The Canadian 2-year yield has fallen 42 bp over the past month and 64 bp over the past three months. The US 2-year yield has fallen 16 and 33 bp respectively. That leaves the differential at about 80 bp down, from around 111 bp in mid-May. The differential on the 10-year sector has also narrowed, but not as dramatically.

Canada reported earlier today that foreign investors were net sellers of Canadian financial assets in June to the tune of C$3.5 bln. Foreigners were net sellers of Canadian bonds for only the second month since Dec 08. Since then foreign holding of Canadian bonds is up by almost a third. Essentially, foreign investors did not fully recycle the C$6.4 bln of maturing Canadian bonds they held into bonds in the secondary market. Foreign investors were buyers of Canadian stocks (C$2 bln). Two sectors were targeted: gold and technology firms, according to Statscan.

For their part Canadians reduced their holdings of foreign bonds by C$3.2 bln and June was the fourth consecutive month of this divestment. They sold C$4 bln worth of US Treasuries, but were small net buyers of JGBs and other major bonds. Canadians continued to buy foreign shares as they have consistently all year. US equities counted for the lion's share.