Canadian Loonie Should Lead G7 Currencies Now

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By Scott Boyd

Now that the uncertainty that comes with the constant threat of defeat of the previous minority government has been set aside for at least the next four to five years, the Canadian dollar is quickly establishing itself as a top choice for investors. Canada has had a succession of minority governments over the past seven years. Yet with the emergence of a Conservative majority government following Monday’s federal election, investors are expected to once again turn to Canada and the Canadian dollar as choice investment opportunities.

Known as the “loonie” for the waterfowl depicted on the back of the one dollar coin, the Canadian currency is expected to gain from strong fundamentals and the stability of a government that no longer faces the constant threat of being tossed out of office by a collection of the opposition parties. This new political landscape, together with Canada’s reputation of sound fiscal management that saw the country through the recession better than most of its contemporaries, is earning Canada rave reviews on the markets.

Only days after the election, PIMCO’s Bill Gross, who manages the world’s largest mutual fund with assets exceeding US$240 billion as of the end of 2010, offered a rousing endorsement for both Canadian and Australian bonds. Gross suggested that rather than U.S.-denominated securities, his clients should look at some of the developing economies with “more pristine” balance sheets and higher interest rates. On the other hand, Gross noted that “if AAA quality is your requirement, then Canadian or Australian bonds may also fit your horizon.”

The Loonie’s Bullish Forecast

After contracting by 0.2% in February following four straight monthly gains, a recent Bank of Canada report stated that the economy will likely return to growth in the second quarter. Early estimates are for an annualized rate of growth of 2% for the three months ending in June. The International Monetary Fund was even more bullish on Canada, predicting the economy will grow by 2.8% for the year.

As usual, it will be the export of in-demand commodities that drives this growth and Canada is well-positioned as a leading supplier of goods ranging from oil and energy, to copper and wheat. The one cautionary aspect is that the U.S. accounts for roughly 70% of Canada’s exports. While growth is slowly returning to the U.S., prospects for a full recovery south of the border are far from a done deal.

This reality is less of an issue today than it would have been twenty years ago, as Canada has forged strong trading relationships with other countries in recent times. Most notably, many of the emerging Asian economies are particularly eager to acquire the goods and resources produced by Canada and this has opened up additional export market opportunities. Coincidentally, this is just one of the reasons why Canada was able to get through the recession in reasonably good shape and this will continue to serve Canada well as the global economy continues to expand.

Finally, with the level of growth being predicted, the prospect of an interest rate hike certainly comes into play. The Bank of Canada has already said it expects inflation to be near the Bank’s target of 2% . If the Bank does raise rates late in the year, demand for the loonie will grow. Several analysts have suggested the Canadian dollar is in line for gains against most of the major currencies, and the U.S. dollar in particular. ING has suggested the loonie could strengthen from the current 95.25 cents to the U.S. dollar to 92 cents by the end of the year.

Disclosure: None

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