Canadian dollar set to outperform commodity rivals

Fri Jan 21, 2011 11:23am EST
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By Neal Armstrong

LONDON (Reuters) - A shift by investors in commodity currencies should see the Canadian dollar outperform its close rivals, buoyed by a hawkish interest rate outlook, high oil prices and an improving picture for the U.S. economy.

The Bank of Canada may have sounded a less hawkish tone than some had been anticipating when it kept interest rates on hold on Tuesday, but most Canadian primary dealers still see a rate hike coming in the first half of the year, according to a Reuters poll.

Analysts expect the rate outlook to keep the currency on a firm footing against the Australian and New Zealand dollars. All three are growth-linked currencies and are generally sought after when investors grow bullish about the global economy.

"Market pricing for Canada rate hikes is still more aggressive than for Australia or New Zealand," said UBS currency strategist Gareth Berry "For this reason we expect to find profitable opportunities this year in rotating out of the Aussie and New Zealand dollar longs and into the Canadian dollar."

With commodities prices at two-year highs, according to the Reuters Commodity Index and Australian interest rates at nearly 5 percent, investors flocked to the Australian dollar in 2010, but the impact of rate hikes and severe flooding has dented consumer confidence and the Aussie rally has stalled.

Financial markets, based on interest rate swaps and the futures market, are pricing in the chance of only one quarter percentage point interest rate hike by the Reserve Bank of Australia in the next twelve months.

Investors are fully pricing in two New Zealand rate hikes, and a 40 percent chance of a third this year. but there is a chance this could be pared back as New Zealand stares at a return toward recession after unexpectedly slow economic growth in the third quarter of 2010. Analysts say benign inflation could delay rate rises.

Canadian overnight indexed swaps, which trade based on expectations for the key central bank rate, show the implied rate at 1.57 percent, implying two full hikes and a 30 percent chance of a third by December.   Continued...