Commodity prices also poised to fall as fundamentals lift U.S. dollar

TORONTO, Nov. 10 /CNW/ - The loonie's climb near parity with the U.S. dollar should hold steady into the new year but is vulnerable to a pullback before spring, notes a new report from CIBC World Markets Inc.

There are a "few more months in which the loonie could flirt with levels a bit through parity," says CIBC's Chief Economist Avery Shenfeld in the latest Global Positioning Strategy report.

But the factors giving the loonie its strength, such as a slumping U.S. dollar and rising commodity prices, appear set for a correction in early 2011, says Mr. Shenfeld.

The "heavy wave of selling" that has weakened the U.S. dollar "reflects the mistaken view that the (U.S. Federal Reserve) is flooding the world with greenbacks and that quantitative easing is by design a way to debase the dollar by excess supply."

Mr. Shenfeld points to broad measures of money supply that show there's been no surge of U.S. dollars into the market. "The money created by buying trillions of bonds is simply sitting idle, having been deposited by American banks as excess reserves in their account at the (U.S. Federal Reserve)."

Mr. Shenfeld further notes that the Eurozone money supply has been growing at a similar pace to that of the U.S., while Canadian money supply has actually been on a faster trajectory. That reality suggests that the U.S. dollar selling in response to quantitative easing has been overdone, making the Euro, Yen and loonie vulnerable to a correction.

"The most likely trigger (for that correction) will simply be the market getting disenchanted with economic developments in the countries whose currencies have been in favour," says Mr. Shenfeld.

"The eurozone fiscal malaise leaves a likely default down the road in Greece, and recessions in the near term for the likes of Spain and Ireland. Export dependant Germany and Japan are going to struggle at current exchange rates, as will Canada for that matter."

The outlook for commodities is much the same, says Mr. Shenfeld. "While there has been some support from decent growth indicators out of China, most of the upswing in oil, copper and, of course, gold, has been simply the mirror image of the weak dollar as quantitative easing talk took hold. If, as we expect, the winter sees a correction in the U.S. dollar's favour, don't be surprised if a bit of the wind is taken out of the commodity ship's sails as well."

Mr. Shenfeld has revised his year-end target for the loonie to 99 cents U.S. and sees it dipping to 93 cents U.S. by the spring on disappointing economic growth and a strong U.S. dollar.

Longer term, however, there are factors that could see the Canadian dollar return to an appreciating trend as global economic growth gradually improves, notes CIBC's Head of Currency Strategy Jeremy Stretch in the same report. Among them is the expectation that markets associated with commodity revenue streams, like Canada's, will experience higher longer term GDP growth than those without such streams. Another factor is a move among central banks to diversify their FX reserves. This trend has resulted in increased holdings of the loonie, and the prospect of ongoing reserve diversification is likely to maintain "a long term residual bid for commodity currencies," says Mr. Stretch.

CIBC's forecast sees the loonie climbing back from its winter retreat, reaching 99 cents U.S. by December 2011.

The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/gps_nov10.pdf

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