When Will Canadian Dollar Resume Rally?

The Canadian Dollar's recent rally stalled when parity with the USD was achieved. In retrospect, there were probably too many speculative longs who grew impatient. The latest weekly COT report showed that there had been modest long liquidation by both large and small specs, but even after the small washout, they remained committed to a higher C$. Large specs in the last report were long 46.5%, and the small specs 32.5% of the total market.

Later in the week we will get some important Canadian and US statistics. Thursday we get a Canadian building permit report and an IVY PMI report, anticipated to be 59.3 ahead of the previous 57.3. On Friday we get the employment change and the employment rate, expected to be 8.2%. On Thursday, in the US, we get the first time unemployment claims, forecast at 442k down from 448K. This will be followed on Friday with the unemployment rate, expected to remain at 9.7%, and the highly volatile and non predictable NFP report which is projected to be 197K.

Central bank rates in both the US and Canada are the same at 0.25%. For the past several months, the Canadian Central Bankers have indicated they might be one of the first to raise rates. Originally July had been the target date but hints were made the new time might be June. The Financial Post reported this morning:

Canadian Finance Minister Jim Flaherty said on Monday that while the economic recovery is under way, risks still lurk, including global credit issues and high domestic unemployment.

This would indicate that the finance minister is wary of an immediate increase in rates, but should the data later this week show major differences in the recovery rates of the two countries, this may provide us with some clues when the Canadians will increase the rate.

With the US Treasury's massive borrowing needs, the US is trapped with cheap rates for a longer period of time. US Banks have been aggressive buyers of Treasuries during the past year. To get the money for these purchases, the banks borrow short term for practically nothing, and lend as far down the yield curve as they dare, leveraging their capital and, as an example, getting back 3.7% yearly for a 10-year note.

What recourse would the Fed have if inflation starts up? Traditional inflation treatment calls for higher short rates, perhaps an inverted yield curve, but what about the banks that have borrowed short from the Government? Since higher short rates in the US would cause another bank crises, we look for the Canadians rates to advance much faster than the US. Combine this with the possibility of higher energy prices, and weakness in the euro, redirecting some reserve funds to Canada, this looks like a set up for the loonie to trade above parity with the USD.

Use periodic weakness in the C$ versus the USD to sell the USD eventually looking for a trade in the 0.98 area. For those more adventuresome, consider buying the C$ selling the yen in the 0.9260 area. It is a bank holiday through Thursday in Japan, which may cause volatility to expand.

(Click to enlarge)

Disclosure: No positions