Tags: Canada, Canadian Dollar

Canadian Dollar Dances with Dipping Commodities

By , Money Morning •

By Mike Caggeso
Associate Editor

The Canadian dollar had possibly the best year of all world currencies. Its performance against the U.S. dollar is one for the record books - on Nov. 7, almost six weeks after eclipsing parity with the U.S. dollar, the loonie peaked at $1.0837 against the U.S. dollar, a 27% year-to-date appreciation against the greenback.

But that day was also the currency's jump-the-shark moment, because what propped it up so high is what inevitably brought it back down - record commodity prices, namely gold, oil and uranium.

And not coincidentally, drops in the price of gold and oil in the past few weeks have pulled the Canadian dollar down to $1.0148, threatening parity once again just as many Canadian Christmas shoppers are planning trips across the border in search of "bargain U.S. prices."

Adding to the buck-related buzzkill, Bank of Canada Governor David Dodge said that an interest rate cut is possible early next year due to "risks" to the country's economic growth. Those risks were vague, at best, including "growing threats to the global economy" and "volatility in financial markets," Dodge said, according to Bloomberg News - and somewhat directed at the U.S. credit market. Even so, the comments suggest that the Canadian central bank may cut borrowing costs by reducing the current benchmark rate of 4.5%.

And if Dodge & Co. pulls the trigger, Canada can say goodbye to its high-valued currency.

"The central bank has started to take note of the downside risk coming from the trade side," David Watt, a senior currency strategist at RBC Capital Markets in Toronto, told Bloomberg. "The days of easy gains in the Canadian dollar are gone."

But no one can say they are surprised by the talk of a rate cut. In early September, the Bank of Canada held interest rates steady, but noted that credit troubles stemming from the U.S. subprime fallout could lead to a rate cut down the road. And since then, U.S. Federal Reserve Chairman Ben S. Bernanke and fellow central bank policymakers cut interest rates twice.

"Against this background, the Bank judges that the current level of the target for the overnight rate is appropriate. However, there are significant upside and downside risks to the outlook for inflation. On the upside, there is a possibility that household demand in Canada could be stronger than anticipated, while on the downside the ongoing adjustment in the U.S. housing sector could be more severe and spill over to the U.S. economy more broadly," the Bank of Canada's statement said. 

The Canadian Press suggested a wild card could control the fate of the loonie - China's massive [and government-controlled] foreign exchange holdings and the country's lethargy in responding to problems caused by the slumping dollar. 

Even though Canada's economy is one-tenth the size of the American economy, Ottawa estimates it shouldered a third of the brunt of the dollar's depreciation. If that estimate is true, it only makes the Canadian dollar's historic run this year all the more impressive.

'Border'line returns

If anything, the timing of a devalued Canadian dollar couldn't be better. As mentioned earlier, a strong loonie gives Canadians more buying power in the U.S. market, where they can scoop up retail deals, not to mention cheaper cars and appliances. Over the summer, a cheap dollar and strong loonie sent more Canadians across the U.S. border for vacation.

But as we head into our unofficial holiday shopping season - from "Black Friday" [the day after Thanksgiving] to Christmas - fewer Canadian shoppers will cross the U.S. border looking for deals because a weaker currency means it's finally once again more worth their time and money to shop in their home market.

Should the Canadian dollar dip further in the next few weeks, it'll be a blessing of sorts for the Canadian economy. Retail sales figures are one of the leading indicators of economic health, and a strong retail rally may persuade the Bank of Canada to hold off on cutting rates, which would in turn return buying power to the loonie.

It's an odd way to full circle back to strength, but it's very possible.

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