The Canadian dollar could quickly recover more than half the massive losses it has sustained this month once banks, hedge funds and other big investors no longer have to buy vast quantities of greenbacks and yen to cover short positions in those currencies, CIBC World Markets said Friday.
“It's not interest differentials that are driving the foreign exchange move,” CIBC senior economist Avery Shenfeld said in a note to clients, as the loonie was hovering at between about 78.50 cents (U.S.) and 78.70 cents in midday trading, down more than 15 cents from the beginning of October. “Instead, it's a wave of ‘forced' U.S. dollar and yen buying to cover short positions created by other asset price developments.”
But this wrenching process could be over “quite soon” and bring a “significant snap-back” for some of the many currencies that have plunged against their U.S. and Japanese counterparts.
“For the C$, the last five or ten cents of decline might be reversed as fast as they came, with further gains in the latter half of next year as the global economy and commodities rebound,” Mr. Shenfeld said.
“It may take longer to get back to parity if we start from 75 cents or worse, but a country blessed with scarce resources that the world will again be clamouring for, will, a couple of years from now, have a currency that's back on par with the greenback.”
The loonie, already pummelled by plunging commodity prices, continued to lose altitude against the surging greenback Friday as North American stock markets joined a renewed plunge in European and Asian equities triggered by growing fears of a worldwide recession.
Before those markets opened, the Canadian dollar hit a four-year low of 77.87 cents.
The loonie was in good company, as an ongoing stampede into the U.S. dollar continued to crush most other major currencies, except the yen and the Swiss franc.
“It's unbelievable,” said George Davis, chief technical analyst for Royal Bank of Canada in Toronto. “We've seen a dramatic spike in risk aversion overnight ... and I think that type of environment is going to lend itself to some additional U.S. dollar gains.”
Britain's pound was hit even harder than the loonie Friday, after the government disclosed that the nation's economy shrank by half a percentage point in the third quarter, double the contraction economists had forecast.
The pound responded by plummeting as far as $1.5269 (U.S.) from $1.62 late on Thursday, marking the “biggest nosedive for sterling since 1971,” according to a Bank of Montreal commentary.
The Australian dollar, too, took a particular pasting, falling to as low as 60.57 cents overnight, down fully 6.39 cents.
Meanwhile, the yen continued to swim against the tide. Early Friday morning Japan's currency strengthened to the point that it cost just 90.93 yen to buy a greenback, a 13-year low, down 6.38 yen from Thursday, although it subsequently dipped back to 92.50.
The yen's rise has come as investors, again seeking to move to less risky positions, are stampeding to unwind so-called carry trade positions they built up before the global financial system imploded.
In the carry trade, investors borrow money at low interest rates in one country to invest for higher returns in another – with the carry being the difference between the rate they pay and the return they earn.
In Japan's ultra-low interest rate environment, punters would borrow and sell the yen, take the proceeds and invest them in higher-yielding currencies, such as sterling and the Aussie, Mr. Davis said in a telephone interview.
“But what we are seeing now is that, because the crisis has led to significant de-leveraging in the markets, all those carry trades are being unwound, as risk aversion moves higher,” he said. “So, people are now buying the yen and selling currencies like sterling and the Australian dollar, and the dramatic declines [in those two currencies] are representative of that.”
The loonie's performance Friday came as Statistics Canada reported that consumer prices rose by 0.1 per cent in September, which reduced the annual rate of inflation to 3.4 per cent from 3.5 per cent in August.
Bank of Montreal deputy chief economist Douglas Porter told clients in a note that the bottom line of the latest figures show that it is fast becoming the least of policy makers' concerns.
“While this report doesn't make it obvious,” he said, “Canadian inflation is poised to soon recede meaningfully, even with the recent steep selloff in the loonie. U.S. inflation will melt even more quickly.”