Loonie could fly above par with U.S. dollar this summer: CIBC World Markets
Inc.

Interest rate hike expectations, investor demand for Canada are driving dollar higher

TORONTO, March 10 /CNW/ - Multiple forces are at play that could push the Canadian dollar past parity with the U.S. greenback this summer, according to a new report from CIBC World Markets Inc.

"Indeed, we've already seen the Canadian dollar gain several cents in recent weeks as the market began to firm up expectations" of an interest rate hike in July by the Bank of Canada, says Avery Shenfeld CIBC's chief economist. "If as we expect, the Bank is out in front of the U.S. Federal Reserve by a couple of quarters, a higher Canadian dollar will help tighten monetary conditions. It's easy to see the Canadian dollar running a few cents through parity after the first hike."

A rate hike isn't the only event that could lead the Canadian dollar above the greenback. In the latest Global Positioning Strategy report, CIBC Analyst Zafar Bhatti identifies four other factors that could help lift the loonie. They are:

    
    -   World demand for commodities: increased demand for commodities such
        as oil, minerals and fertilizer "could result in a stronger Canadian
        dollar as exporters repatriate profits."

    -   Resurgent capital markets: Canada is one of the friendliest
        environments for foreign acquisitions, says Mr. Bhatti. "If the
        capital markets finally get an appetite for M&A then Canada could be
        one of the first places to see the benefit of foreign inflows."

    -   The carry trade: The U.S. dollar has become a "carry currency"
        meaning that investors are borrowing U.S. dollars at low rates and
        then investing them in foreign markets in an effort to pick up the
        yield differential, says Mr. Bhatti. "This investing behavior
        partially explains why the (U.S. dollar-Canadian dollar) exchange
        rate is highly correlated to the TSX. In simplistic terms, (the U.S.
        dollar) converts to (Canadian dollars) as the TSX goes up and
        converts back as the TSX declines."

    -   Fears of sovereign default: "If the investing world starts looking
        for a place to park capital in the wake of deteriorating sovereign
        credits then Canada would look very attractive," Mr. Bhatti writes.
        "Canada is one of the few remaining AAA credits with a healthy
        outlook and the Canadian dollar could benefit from a switch trade out
        of weak sovereign names to Canada."
    

CIBC's currency forecast sees the loonie reaching $1.02 versus the U.S. greenback by September before dipping back to $.97 by year end. This view reflects the expectation that the Bank of Canada will raise interest rates in the third quarter, a full six months ahead of the U.S.

"Nobody should be surprised if the Bank of Canada begins hiking rates as soon as its June-end line in the sand has passed," says Mr. Shenfeld, adding he expects rate increases will be implemented at a measured pace.

"There's the uncertainty that the Bank of Canada will still face regarding the global outlook after 2010. It's not just Canada that will be weathering a fiscal tightening - it's the U.S., Europe, Japan and China as well. Banking reforms could restrain lending room globally, and the U.S. housing market, the root source of the 2008-09 shock, is still a mess. Going full bore with rate hikes in the first year or so of recovery risks having to do an about-face if any of these minefields blow up," says Mr. Shenfeld.

He acknowledges a slowdown in hikes after an initial increase may contradict the past. "History shows that in the market's eyes, rate hikes are like potato chips - once you open the bag and take the first bite, you end up eating them all. Once one hike is in the books, investors are likely to tack on many more to existing expectations, whether justified or not."

However, uncertain global economic conditions will require a different approach. "Indeed, we expect fiscal tightening, the end of the initial inventory cycle boost to U.S. growth, and a cautious consumer stateside to visibly slow North American growth in the latter part of the year, putting Canada's rate hike cycle on pause after only the first 75 bps of hikes this summer."

The complete CIBC World Markets report is available at:

http://research.cibcwm.com/economic_public/download/gps_mar_10.pdf

CIBC's wholesale banking business provides a range of integrated credit and capital markets products, investment banking, and merchant banking to clients in key financial markets in North America and around the world. We provide innovative capital solutions and advisory expertise across a wide range of industries as well as top-ranked research for our corporate, government and institutional clients.

For further information: Avery Shenfeld, Chief Economist, at [phone], [email protected]; or Tom Wallis, Communications and Public Affairs at [phone], [email protected]