CANADIAN DOLLAR

After a 1.1% rally on Monday, traders ditched the Canadian dollar for all it was worth Tuesday as the Finance Minister made veiled threats about intervening to stem the appreciation of Canada's domestic currency. The U.S. bought C$1.0739 Tuesday from C$1.0658 the day before. During July a 7.9% appreciation made it the best performer against the dollar as commodity prices sprang back to life with vigor.

On Tuesday one Canadian dollar bought 94.08 American cents as the rally reached fever-pitch. The Canadian economy relies largely on oil for strength these days and good news for global growth is bullish for oil, which creates a self-feeding demand for what the locals call the loonie. The dollar coin has a picture of an aquatic bird native to the nation, hence its nickname.

Jim Flaherty referred to "steps" that could be taken to dampen its "rapid appreciation." Clearly, the Finance Minster was referring to selling the currency. His comments echo comments stemming back to the depths of economic recession in March when Bank of Canada governor, Mark Carney discussed the offsetting impact that currency appreciation was having no the local economy when growth hadn't gained traction.

In July that message changed its tone given the improvement in domestic and international data, which essentially took the pressure off the currency. With interest rates down at 0.5% it's hard for the Bank of Canada to further ease monetary policy, which is why the market was so swift to conclude that it was currency sales that Mr. Flaherty eluded.

Indeed the Canadian central bank has pretty much stated that policy is likely to remain on hold until June 2010. Mr. Flaherty's comment was likely aimed at speculative longs in the market place - something we're equally guilty of within our trading services. We recommended buying the Canadian dollar four weeks ago when it stood at 85.79 U.S. cents.

The first step any good central bank - treasury minister tag team should do is to warn them market. That's known in the trade as jawboning. If they can't successfully ward off speculators, the next step is to physically intervene. That's often done unilaterally and we've seen this discreetly from the Reserve Bank of Australia - another commodity-sensitive currency. The RBA has sold significant amounts of its own dollars in May and June records show. Unilateral intervention is often unsuccessful at doing more than temporarily depressing the value of its currency.

Central banks tend to find themselves fighting the trend and often intervention is useless. The best policy is to join ranks with other agreeable central banks and take on the market in a joint show of force.

So what to make of Tuesday's comments to reporters? Frequently, finance ministers often find themselves held hostage to vogue topics and they tend to take the line of the central bank's philosophy. That's possibly the situation here. Mr. Flaherty needs to put his money where his mouth is, otherwise the market will continue to take the path of least resistance, which in the case of the Canadian dollar is towards parity.

Which Texas-based sugar manufacturer
is set to rally 32% before year end
if the commodities markets continue to reach for the sky?
Find out in the August issue of Global Resources Alert!!

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