Canadian dollar falls third day before Fed policy announcement

December 18, 2013 06:06 AM

The Canadian dollar weakened (FOREX:CADUSD) for a third day before a Federal Reserve rate decision that may see the central bank slow the monetary stimulus that is thought to depress the value of the U.S. currency.

Canada’s dollar fell against most of its major peers after Bank of Canada Governor Stephen Poloz told Bloomberg News yesterday that recent declines in the currency weren’t enough to help exporters. U.S. 10-year Treasury note (CBOT:ZNH14) yields rose amid mixed forecasts over whether the Fed will decide today to reduce its $85 billion monthly bond purchases. The Canadian dollar is the most inversely correlated with U.S. benchmark yields since 2004, meaning when yields rise, the currency falls.

“If the minority view that the Fed does taper at this meeting is realized, you’d see a very strong U.S. dollar positive response, so unfortunately that would weigh quite clearly on the Canadian dollar,” said David Tulk, chief macro- strategist at Toronto-Dominion Bank’s TD Securities unit, by phone from Toronto. “The bulk of the community and the market is still positioned for a January taper.”

The loonie, as the Canadian dollar is known for the image of the aquatic bird on the C$1 coin, fell 0.6% to C$1.0666 per U.S. dollar at 10:57 a.m. in Toronto. The currency touched C$1.0708 per U.S. dollar, its lowest point in three years, on Dec. 6. One loonie buys 93.76 U.S. cents.

Bonds Drop

Canada’s benchmark 10-year government bond fell, with yields rising four basis points or 0.04 percentage point, to 2.68%. The 1.5% security maturing in June 2023 lost 29 cents to C$90.26.

The extra interest available in Canadian two-year government bonds over their U.S. counterparts narrowed to the least the biggest advantage in more that six months. The yield premium fell to 76.7 basis points, the least since May.

The 150-day inverse correlation between the Canadian dollar and U.S. 10-year Treasury yields rose to minus 0.41 on Dec. 10, its strongest since August 2004, from minus 0.05 at the start of the third quarter. A reading of 1 means they’re in lockstep, while minus 1 means they move in opposite directions.

Since the start of 2013, the loonie’s correlation with Treasury yields increased 0.97, the most among its Group of 7 peers, excluding the U.S. dollar.

‘Diverging Policy’

Implied volatility for three-month options on the U.S. dollar against its Canadian peer fell to as low as 6.27% on an intraday basis, the lowest point since Nov. 22. The measure is used to set option prices and gauge the expected pace of currency swings. The 2013 average is 6.7%.

The cost to insure against declines in the loonie versus its U.S. counterpart touched the lowest in nearly 11 months, with the three-month 25-delta risk-reversal rate dropping to 0.87% on an intraday basis. The average this year is 1.26%. Risk reversals measure the premium on options contracts to sell Canadian dollars versus buying U.S. contracts that do the opposite.

“The option market isn’t concerned about the risk of U.S. dollar upside, and I think in terms of CAD we’re just ignoring the positive surprises in terms of the data,” said Camilla Sutton, head of currency strategy at Bank of Nova Scotia, by phone from Toronto. “I think most are short CAD on the outlook for diverging policy between the Fed and the Bank of Canada.”

Bernanke, Poloz

The Fed will start reducing purchases this month, according to 34% of economists surveyed by Bloomberg on Dec. 6, versus 17% a month earlier. Twenty-six percent forecast January and 40% said March. Fed Chairman Ben S. Bernanke will hold a press conference in Washington after the decision.

Poloz said exports and investment have been disappointing and inflation has been “lower than we can explain” during an interview at Bank of Canada headquarters yesterday. The central bank’s forecast is that the economy won’t reach full output until around the end of 2015.

“Given what we know today,” he said, “something really unusual would have to happen to get us back to home base in less than two years.”

The loonie remained lower today even after Canadian wholesale sales rose the most in three months in October, exceeding the highest forecast of economists on increased machinery receipts.

Sales rose 1.4% to a record C$50.5 billion ($47.5 billion), Statistics Canada said today in Ottawa, compared with the median estimate of a 0.3% gain in a Bloomberg survey with 13 responses. The most optimistic estimate called for a 0.6% increase.

The loonie has dropped 4.4% this year against the nine developed-nation currencies in the Bloomberg Correlation- Weighted Indexes, while the U.S. dollar has added 3.6%. The yen leads decliners, with a plunge of 15%, and the euro’s 8.6% advance paces gainers.

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