The Case for Dollar Relief Already Weakening

By Dr. Duru written for One-Twenty

July 22, 2009

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The Fed's official announcement of its exit strategy motivated me to make a soft case for a relief rally for the U.S. dollar. The ink was not even dry when I learned that the Canadian Central Bank may instead have greased the skids.

On Monday, the Bank of Canada left its interest rate target at 0.25%, adding that "conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target." Bank Governor Mark Carney also seemed to give a relatively hopeful and optimistic outlook on the economic recovery in Canada and across the globe. The Bank of Canada even seems close to declaring an end to Canada's recession. Contrast these remarks to U.S. Federal Reserve Chairman Ben Bernanke's "Semiannual Monetary Policy Report to the Congress" on Monday in which Bernanke reiterated the Fed's concern about stubbornly high rates of unemployment and the resulting downside risks to the economy. The apparent brighter outlook for Canada's economy, heavily dependent on commodity exports, supports continued strength for the Canadian dollar.

The big wildcard is whether the Bank of Canada will attempt to do anything about the loonie's rise besides trying to talk the currency back down. In May, Carney raised eyebrows after mentioning a strengthening currency as a downside risk to the Canadian economy. The foreign exchange markets responded by selling the loonie the entire month of June even as other major currencies held steady. Now, the loonie has almost recovered all of those losses, and the latest statement from the Bank of Canada still includes the warning: "...the higher Canadian dollar, as well as ongoing restructuring in key industrial sectors, is significantly moderating the pace of overall growth." If Thursday's Monetary Policy Report does not contain stronger language about the loonie's rise, then it could be off to the which case, I will have to go back to my overall long-term bearish stance on the U.S. dollar. Of course, as always, renewed weakness in global stock markets could send traders scurrying back (temporarily) for cover under the U.S. dollar's umbrella. (Also see "Carney's dollar dilemma" for other interesting, related commentary).

Be careful out there!

Full disclosure: long USD/CAD. For other disclaimers click here.

DR. DURU®, 2009