Loonie closing in on greenback

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The loonie is taking flight and is fast approaching parity with the U.S. dollar, which can be expected to weaken if global credit worries continue to ease, said Rob Wittmann, the chief executive officer for Knightsbridge Foreign Exchange Inc.

The U.S. dollar had recently picked up strength against both the euro and the U.K. sterling as investor worries grew over the government debt problems facing Greece, Britain and other countries. That helped to mask the gains being made by the loonie against the greenback, Mr. Wittmann said. The loonie rose 0.55 of a cent to 98.62 cents (U.S.) on Tuesday.

But the strength in the U.S. dollar is now being reversed as demand for safety wanes as speculators sense Greece's problems are being resolved, he said. Yesterday, Greece had the threat of a credit-rating downgrade by Standard & Poor's lowered, according to Bloomberg News.

"The currency market is [also]starting to price in a rate increase by the middle of the year by the Bank of Canada," Mr. Wittmann said. Canada's financial health as measured by the gross domestic product, employment, the health of the banking system and strong commodity prices would suggest the central bank can raise interest rates before the U.S. Federal Reserve Board does, he said.

The Fed policy statement yesterday suggests that it is in no hurry to raise the federal funds rate any time soon.

"The Fed's statement was probably more dovish than the market had expected," said Camilla Sutton, a currency strategist with Scotia Capital Inc. There is little pressure on the Fed to raise rates because there is a lack of inflation pressure and although the employment picture has improved, there are no signs of job growth, Ms. Sutton said.

"I think we should see Canadian dollar strength," Ms. Sutton said. "I think the Bank of Canada will prove to be more aggressive than markets are pricing in." (The Bank of Nova Scotia forecasts the Bank of Canada and the Fed will raise interest rates in tandem.)

Although there is speculation that the Fed will begin to raise rates in the second half of 2010, that does not necessarily imply the U.S. dollar will strengthen, Ms. Sutton said. Based on a study of the past three Fed rate hiking cycles in 1994, 1999 and 2004, the "currency reaction leading into and after the first interest rate hike is far from uniform," she said in a report to clients. "Accordingly, as we approach tighter U.S. monetary policy we caution that currency reaction to higher U.S. interest rates might not be a stronger U.S. dollar. The last three U.S. cycles imply that currency valuations are based on more than just interest rate differentials."