The Dollar

The Canadian dollar continued strength is the last element of a complex situation; first Canada is in the enviable position of having a healthy financial system, a somewhat healthy housing market (there could be a correction of 10% to 15%), and a central bank that has the confidence of the market.  Finally, and this is the surprising element, a healthy manufacturing sector, with growth in exports of 17% in the 4^th quarter of 2010 – flying in the face of the generally agreed position that Canada’s manufacturing could not sustain parity with the U.S. dollar – when in fact, via heavy capex program, Canadian manufacturing is doing rather well (productivity has to be rising..right?).  

Canadian manufacturers know the currency appreciation game well.  In June 2002, the Canadian dollar stood at 0.62 to the US dollar, an all time low, since then the Canadian dollar has appreciated by 66% -- so Canadian manufacturers are well versed in dealing with an appreciating currency.  My bet was that Mark Carney, the Governor of the Bank of Canada would raise interest rate on March 1^st, his first chance to do so, but I was in a minority of one!  The market believes that any rise in Canadian interest will only occur after the Feds start raising interest rates (Canada has never has a 1% interest rate differential with the US).  Bets are now being taken for a May 1^st raise, but there are many factors in the way, oil prices for one, although Canada is an important exporter it’s a heavily energy dependent (something to do with our bitter winters I guess), which is already impacting the economy.

Nevertheless, Canada’s economy is doing remarkably well, inflation is well within the bank of Canada’s preferred range, near 2% and GDP growth for 2010 seems to have ended around 3% (0.2% lower than my initial 2010 prediction).  The odds for a stronger Canadian dollar are somewhat limited , tied as it is to the U.S. dollar (our largest export market), but and this is important Canadian exports are increasingly moving away from the US, last week the US government began its lumber fight again, wanting to impose countervailing duties on our lumber exports.  In the past, this would have made the headlines of all Canadian newspapers, today it was hardly mentioned because the U.S. is a shrinking market for Canadian lumber; instead it is put on ships and sent to China!  I suspect that this was not the reaction the Americans were expecting, Canadian lumber will not go to the US, it will go to China instead, kind of robs the American punch (this fight has been going on for 30 years).

I anticipate that unless interest rate rise soon the CAD will be blocked at the 1.03/05 range, and may even decline thereafter – on a purchasing parity basis the CAD is now 5% to 10% “overvalued”, granted PP is not the only measure, but it is important measure of when currency should trade on a long term basis.