Loonie Loses Currency Wings as Canada Reels From U.S. Slump

By Liz Capo McCormick

Aug. 4 (Bloomberg) -- Currency traders are beginning to realize that for all its riches in oil, copper and lumber, Canada's economy may not be so different than the U.S. after all.

While Canadians celebrated last year as the country's dollar reached parity with its U.S. counterpart for the first time since 1976, traders now predict the currency will fall as much as 17 percent through 2009.

After soaring 17 percent in 2007, the loonie, as the currency is known because of the aquatic bird on the one-dollar coin, is down 2.8 percent in 2008 amid a shrinking economy and an 18 percent drop in oil prices the past month. It's one of five of the 16 most-widely traded currencies to drop against the U.S. greenback, joining the New Zealand dollar, South Korean won, South African rand and British pound.

``The way energy prices and certain commodities have boomed, many thought we would weather the downturn better,'' said Steve Butler, director of foreign-exchange trading in Toronto at Scotia Capital Inc., a unit of Canada's third-largest bank. ``You've got a pessimistic look at the economy by the market. It's forced a lot of people to rethink that view.''

Canada's economy shrank 0.1 percent in May, as the extraction of natural gas slowed and car production dropped, Statistics Canada said last week in Ottawa. Economists surveyed by Bloomberg predicted a 0.2 percent expansion, according to the median of 24 estimates.

Forecast Cut

The Bank of Canada cut its 2008 growth forecast on July 15 to 1 percent from 1.4 percent. That's even less than the U.S., where the economy is likely to expand 1.5 percent, according to the median estimate of 81 analysts in a separate poll.

Canada's currency closed last week at C$1.0272 per U.S. dollar, depreciating 13 percent since it reached 90.58 Canadian cents on Nov. 7, the strongest since 1950.

The loonie will slide to C$1.05 by the end of December, and to C$1.09 by the start of 2010, according to the median estimate of 30 strategists surveyed by Bloomberg. New York-based Lehman Brothers Holdings Inc. is the biggest bear, predicting the currency will weaken to C$1.15 this year and C$1.20 in 2009. Paris-based BNP Paribas, the most accurate foreign-exchange forecaster in a 2007 Bloomberg survey, predicts C$1.12 this year.

``The Canadian dollar is extremely overvalued at these levels,'' said Momtchil Pojarliev, head of currencies at London- based Hermes Pension Management Ltd, which has about $70 billion under management. ``Oil prices have come down quite a lot from their peak but the Canadian dollar still hasn't moved at all. The currency should also weaken due to the weaker economic data.''

Export Driven

Commodities such as gold and crude oil account for 54 percent of Canada's exports. As the price of crude oil soared 57 percent in 2007 to $95.83 a barrel, Canada's economy expanded 2.54 percent, compared with 2 percent in the U.S.

And though oil surged 53 percent this year to a record of $147.27 a barrel on July 11, it has since slid to $125.10 on speculation that high prices may cut demand for fuel in the U.S., the world's largest energy consumer. U.S. motorists drove less for a seventh consecutive month in May, pointing toward the first annual drop in road travel since 1980, the Federal Highway Administration said in a report last week.

``From a technical and fundamental perspective, we are looking for the Canadian dollar to weaken,'' said George Davis, chief technical analyst in Toronto at RBC Capital Markets, a unit of the Royal Bank of Canada, the country's biggest bank. `Continued contraction in global growth, would be negative for the Canadian dollar.''

Buy Orders

If the currency weakens past C$1.0343, a so-called level of resistance where strategists say orders to buy the loonie may be clustered based on past trading patterns, then it may depreciate to about C$1.0460, Davis said.

The downturn in the Canadian economy is already largely priced into the currency, said Bettina Mueller, a fund manager at Deutsche Bank AG's DWS Investments unit in Frankfurt, which manages $398 billion.

``Commodities are still a positive story, as the strategic direction is upward,'' said Mueller. ``The Canadian dollar is underpinned from this point of view.''

Canada's fixed-income securities are losing their interest- rate advantage over the U.S., further weighing on the currency.

Three-month deposit rates in Canada exceed those in the U.S. by 0.55 percentage point, compared with 0.91 percent in the first quarter. By year-end, the gap will shrink to 0.09 percentage point, according the median estimate of 47 strategists surveyed by Bloomberg News.

Story `Over'

``Canada's own sluggish domestic fundamentals suggest their interest rate cycle will lag'' behind an increase in U.S. rates, said Peter Pontikis, a treasury strategist at Brisbane, Australia-based Suncorp-Metway Ltd., the country's third-largest general insurer. ``Like many good stories, as the Canadian dollar had been, it is over. We are targeting a retracement back to more comfortable levels at C$1.14 per U.S. dollar, if not higher into end 2008.''

Interest-rate futures show traders no longer expect the Bank of Canada will raise borrowing costs this year.

Policymakers kept the overnight lending rate at 3 percent on July 15 for a second straight meeting, after lowering it four times from 4.5 percent at the beginning of December. Futures on the Chicago Board of Trade show speculators assign a 31 percent chance that the Federal Reserve will raise its target rate, which has been unchanged at 2 percent since April 30, in September.

Interest rates ``will take a back seat to another catalyst: the end of the oil rally,'' said Kathy Lien, chief strategist at currency dealer DailyFX.com in New York. ``The exchange rate will push higher as the rally in oil prices reverses'' with the Canadian dollar weakening, she said.

To contact the reporter on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net;