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“Loonie” Tunes: Behind the rhythm of the Canadian dollar

Written By: Kyle Clapham on March 6, 2012 No Comment

Canada’s dollar finally moved above parity with the U.S. dollar in February in the wake of better-than-expected American economic indicators, only to fall quickly in March on increasing wariness in Europe and dimmer forecasts for China’s economy. Chart courtesy of GoogleFinance. Kyle Clapham/MEDILL

The Canadian dollar reached a five-month high against its U.S. counterpart on March 1, only to depreciate nearly two cents over the next few days and erase much of the ground the currency gained in February.

Canada’s dollar, nicknamed the loonie for the image of the aquatic bird on the C$1 coin, moved below parity and was trading at C$1.0016 per U.S. dollar at 1 p.m. in Toronto on March 6. In other words, one Canadian dollar purchases 99.84 cents. On March 1, the loonie purchased $1.0146.

So what drives Canada’s dollar?

Commodity prices. The loonie is known as a commodity currency because Canada relies heavily on exporting raw materials for income. Foreign trade accounts for nearly half of the nation’s gross domestic product, and half of Canada’s export revenue comes from raw materials such as crude oil, its biggest export, and copper.

“There’s no getting away from the connection between the Canadian dollar and commodity prices,” said Shaun Osborne, chief currency strategist at Toronto-Dominion Bank’s TD Securities unit in Toronto.

When crude rallied to a 10-month high last week as U.S-Iran tensions fueled speculation that global supplies of the commodity might shrink, the loonie climbed to its strongest level against the U.S. dollar since Sept. 19. When crude for April delivery closed at nearly $4 less per barrel in New York on March 5, Canada’s dollar was down more than a cent from March 1.

The U.S. economy. The U.S. is Canada’s biggest trading partner, so investors view positive U.S. economic indicators as encouraging developments for the loonie because optimistic numbers raise demand for Canadian exports, Osborne said.

The currency’s recent peak on March 1 came as U.S. jobless claims fell to the lowest level in four years. But earlier that day, Canada’s dollar briefly pared gains after a U.S. factory gauge unexpectedly fell from January to February, illustrating the close association between the two economies.

Risk. A bullish outlook for the global economy spurs investment in riskier assets such as commodities because economic expansion increases demand for raw materials. Conversely, uncertainty in the global economy deters investment in commodities. Thus, the loonie is also known as a risk currency.

“Canada is one of only two countries in the Group of 10 [industrialized nations] who are oil net exporters, so you’d think high oil prices would be a positive,” said David Grad, currency strategist at Bank of America Merrill Lynch in New York, in a client note March 1. “However, the Canadian dollar has also been very related to the risk theme, and that would dominate.”

Surging oil prices incite economic uneasiness, curtailing risk appetite and strengthening demand for safer assets such as the U.S. dollar. The loonie’s 120-day correlation coefficient with oil prices as of March 1 was just 0.59, much softer than its 0.86 correlation coefficient with the S&P 500 (stocks are risky assets) over the same time, according to Bloomberg. A reading of 1 would indicate the two move in lockstep.

As sentiment about the future prospects of the global economy continues to waver on news from Europe and China, Canada’s dollar will remain volatile.

“Risk is the still big driver of the Canadian dollar, and it still seems to be the biggest driver for the foreign exchange markets at the moment period,” Osborne said.

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