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It sounds like the beginning to a bad joke, right? But seriously, why is the Canadian Dollar (aka Loonie) beating the Australian Dollar (AUD) when the two currencies are placed head-to-head?

The currency markets tend to be very Dollar-Centric, in that they tend to view most currencies relative to the US Dollar (and to a lesser extent, the Euro), rather than to each other. When it comes to the Aussie and Loonie, then, traders at the moment seem content to see them as relatively strong, since both are appreciating against the Dollar. After all, the AUD/CAD pair accounts for only a small fraction of overall trading activity, which means that liquidity is lower and spreads are higher. Why bother?

But this ignores the fact that an important battle is currently being waged by the two currencies not only against the Dollar, but also against the other. It’s not as if the AUD/CAD rate is determined solely based on triangular arbitrage (i.e. indirectly from the AUD/USD and USD/CAD). On the contrary, there are unique factors which determine this exchange rate irrespective of others, as well as specific financial instruments.

But enough with the palavering!Let’s try to understand the idea of parity as it exists between the Loonie and Aussie, and not relative to the Greenback. I like to begin any analysis by looking at a chart. But as with any financial chart, a different time period changes the whole picture. In this case, the 1-year chart shows the Australian Dollar gaining in 2009 (in fact it was the highest performer last year among all of the majors) from the lows of the credit crunch, but retreating in 2010 away from parity. It is this latter trend that I want to elucidate here.

On paper, the Aussie would seem to be the clear favorite. As a result of this month’s interest rate hike by the RBA, the benchmark Australian rate (4%) is now a healthy 3.5% higher than its Canadian counterpart (.5%). This should favor the Aussie among carry traders looking for the highest yield differentials. In addition, the Australian Dollar accounts for a higher portion (6.7% versus 4.2%) of forex turnover than the Canadian Dollar, according to the most recent data, which means that the AUD wins the liquidity battle as well. Meanwhile, Australia’s public debt is near the low end among developed countries, at almost 15% of GDP. After a record 2009 budget deficit, Canada’s public debt is close to 80% of GDP and is among the highest the world. Finally, Australia’s economy was one of the first to emerge from recession (some say it never even officially entered recession), certainly before Canada.

But all of this is in the past. “Canada is on course to be the first Group of Seven nation to erase its budget gap after the global financial crisis.” [Australia should have won this distinction, but alas, it's not a member of the G7]. In 2009 Q4 (the most recent for which data is available), Canada’s economy grew at 5%, compared to 2.7% in Australia. While the US economy – Canada’s largest trade partner – is accelerating, China – Australia’s most important trade partner – is attempting to slow down.

While both the Aussie and Loonie are thought of as commodity currencies, the Loonie is currently benefiting from higher oil prices while the Aussie could suffer from peaking coal and iron ore prices. Volatility (as implied by options contracts) is lower for the Loonie, and this is just as significant as the interest rate differential, when it comes to the carry trade. When you consider finally that “Canada’s financial system was named the soundest in the world for two consecutive years by the Geneva-based World Economic Forum,” its banks are all financially sound, and the attention garnered by the Vancouver Olympics, it’s no wonder that the Loonie is now edging ahead.

Over the last five years, the two currencies have been pretty stable against each other. [Against a basket of other currencies, the Loonie is ahead, with a 20% total appreciation compared to the Aussie's 17% rise]. Thus, the current ebb could be a necessary correction. While analysts like to see things in terms of important psychological milestones, there’s no real reason why the two currencies should trade at 1:1 (parity), and the equilibrium value could very well be below the current level.

This is evidently how the markets feel, as the Aussie just slipped below its 200-day moving average against the Loonie for the first time since 2008. In addition, “Investors paid the largest premium in almost a year last month for Australian dollar put options versus the Loonie. The premium of contracts granting the right to sell the Aussie versus the Canadian currency in one week over those for buying increased on February 8 to 1.18 percentage points, the biggest since April 2009.” After all, the Aussie’s appreciation in 2009 was the highest in 15 years. Perhaps it’s only natural that all else being equal, it should fall a bit in 2010.

The U.S. dollar together with the Japanese yen were the top performers in currency markets before the end of this week’s trading session as multiple events worldwide set risk aversion to higher levels, as the news released today indicated negative surprises for financial markets’ investors.(…)
Read the rest of Dollar Ends Week Advancing on Uncertainties (117 words)

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The Canadian dollar gained for another session, in a rally that seems to be endless, as the Federal Reserve ratified its dovish position on its interest rates, allowing the strong flow of capital from the U.S. towards north to continue for another day.(…)
Read the rest of Canadian Dollar Flirts with Greenback Parity on Commodities (125 words)

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The dollar has started this week losing versus important currencies after the Federal Reserve made dovish statements regarding the country’s interest rates outlook, shunning investors to purchase assets in North America, making riskier assets to climb considerably.(…)
Read the rest of Dollar Suffers from Fed Rates Policy (131 words)

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Following up on my last post, I want to use this post to write about the long side of the carry trade- specifically the Australian Dollar. The Bank of International Settlements (BIS) observed in a recent report that, “The role of short-term interest rate differentials in both the deprecations and their reversal has grown over time.” When you consider that the benchmark interest rate in Australia is now 4% and that interest rates in every other industrialized country (including Japan) are close to 0%, it’s not hard to connect the dots.

Earlier this month, the Reserve Bank of Australia (RBA) raised the benchmark by .25% for the fourth time since it began tightening. In an accompanying press release, the RBA stated that “The board judges that with growth likely to be close to trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average. Today’s decision is a further step in that process. It’s worth noting that the Australian Dollar barely budged, because investors had expected the move. The larger question was, and still is, the ultimate extent of RBA rate hikes and how soon it will get there.

Glen Stevens, Governor of the RBA, has himself indicated that ”rates are still 50 to 100 basis points, or hundredths of a percentage point, below normal.” If you do that math, that means that the RBA will hike rates to 4.5-5% before stopping. Other more bullish analysts think 5-6% is a more realistic expectation because it is closer to the long-term average of Australian rate hikes.

As to when the benchmark will reach that point, it’s anyone’s guess. Going forward, analysts have pegged the liklihood of an April rate hike at 40%. Said one analyst, “It’s now a line-ball call; indeed, if you put a gun to my head . . . I’d guess that the RBA is going to hike again by 25 basis points in April.” Still, most think that the RBA won’t hike again until May. Added another analyst, “They are not indicating any urgency. We think they will go again in a couple of months. It could be three months, it could be two, our formal view is two, that may depend on how the inflation numbers look.” It’s too early to project when the next next (after the next one) hike will take place, because it depends on the timing of the first one.

At this point, most Australian economic data is trending steadily in the right direction. “Australia’s economy is starting a new upswing…Unemployment fell to 5.3% in January, not far above levels considered full employment for the economy…A rebound in construction and an investment splurge in the mining sector are expected to restore growth in the economy back to historic averages by the end of 2010. The RBA has indicated it expects inflation to remain within its 2%-3% target band.” Without drilling too deeply into any of the other numbers, there’s very little reason to doubt that the Australian economic recovery is genuine, which reinforces the notion that it is only a question of when – not if – the RBA further hikes rates.

In fact, the picture surrounding the Australian Dollar is almost a mirror image of the Japanese Yen. While the Yen looks destined to fall irrespective of the carry trade, the Australian Dollar looks destined to fall. While further monetary easing in Japan will give the Yen a second life as a funding currency, higher rates in Australia will once again make it a popular long currency. In short, “With commodity prices likely to remain strong and the spread between Australian and US interest rates likely to widen further its only a matter of time before the Australian dollar breaches parity against the US dollar.”

In fact, the Australian Dollar just touched a 13-year high against the Euro – though that is as much due to the Greek debt crisis and Euro problems as it is with Aussie strength. Meanwhile, the Australian Dollar has zig-zagged against the US Dollar, and is now in a rising trend following a recovery in risk sentiment. Whether it sustains this momentum depends largely on whether the RBA hikes rates next month.

Currencies tied to growth outperformed the U.S. dollar as risk appetite was predominant before foreign-exchange markets closed this Friday, considering that retail sales in North America expanded in the monthly comparison, raising optimism to higher levels among investors.(…)
Read the rest of Dollar Down Before Weekend on Riskier Bets (141 words)

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After gaining for two consecutive days versus important currencies like the euro and the U.S. dollar, the kiwi currency didn’t manage to sustain its trend after central bankers in the country affirmed that lack of economic improvements in the South Pacific nation will delay interest rate hikes.(…)
Read the rest of NZ Dollar Down on Rates Dovish Comments (126 words)

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The Canadian dollar had an amazing eighth day of consecutive gains versus its southern counterpart as currencies tied to growth profited from another session of optimism in commodities and equities markets, allowing the loonie to remain bullish.(…)
Read the rest of Canadian Dollar Keeps Uptrend on Growth (110 words)

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The Canadian dollar traded high versus its U.S. counterpart and several other key-currencies in foreign-exchange markets as its main commodity export, the crude oil, rose again allowing the loonie to start this week advancing.(…)
Read the rest of Canada’s Dollar Gains on National Commodities (121 words)

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The dollar started this Tuesday losing versus European and higher-yielding currencies as positive events in the old continent pushed further up risk aversion in trading markets globally, making the pound and the euro to rank among the best performers versus the greenback today.(…)
Read the rest of Dollar Down after European News (125 words)

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