CANADA FX DEBT-C$ strengthens as investors hope for debt ceiling deal

* C$ at C$1.0367 vs US$, or 96.46 U.S. cents
    * Focus on Washington debt ceiling discussions
    * Canadian bonds outperform U.S. Treasuries

    By Leah Schnurr
    TORONTO, Oct 16 (Reuters) - The Canadian dollar strengthened
against the greenback on Wednesday as investors remained hopeful
a deal would be reached In Washington to raise the U.S.
government's borrowing limit and avoid a potential default.
    U.S. lawmakers prepared for a last ditch effort to come to
an agreement to raise the debt ceiling, with the borrowing
authority set to run out on Thursday. The top Democrat and
Republican in the U.S. Senate were said to be close to agreeing
on a proposal for consideration by the full Senate later on
    The down-to-the-wire nature of the negotiations were
reminiscent of the debt ceiling debate in 2011 when a deal was
reached at the last minute, and investors still believe a
solution will be forthcoming this time around.
    Still, Fitch Ratings on Tuesday warned it could cut the
sovereign credit rating of the United States from AAA, citing
the political brinkmanship citing the political brinkmanship
over raising the federal debt ceiling. 
    This would leave Canada as one of a shrinking handful of
countries with an undisputed AAA rating. 
    Fitch's warning on Tuesday could serve as a warning shot to
U.S. politicians, said Scott Smith, senior market analyst at
Cambridge Mercantile Group in Calgary.
    "The markets seem to be convinced that we'll be able to get
a deal hammered out before we move past this 'x-date' and really
get into trouble with the potential of a technical default,"
Smith said.
    The Canadian dollar was at C$1.0367 versus the U.S.
dollar, or 96.46 U.S. cents, stronger than Tuesday's close at
C$1.0380, or 96.34 U.S. cents.
    A U.S. default would roil markets and economies around the
world. At the same time, the fiscal standoff has seen the U.S.
government partially closed since the beginning of the month.
     Any economic fallout from the shutdown could also impact
Canada, whose largest trading partner is the United States.
    If the likelihood of a default starts to increase, some
investors could push into short-term Canadian treasury bills,
though money is more likely to go into bond markets with greater
liquidity, such as Britain and Japan, said Smith.
    The impact a default would have on the Canadian economic
growth outlook could also limit flows into Canadian bonds, Smith
    On Wednesday, government bond prices were mixed across the
maturity curve. The two year bond was unchanged to
yield 1.234 percent, while the benchmark 10-year bond
 fell 17 Canadian cents to yield 2.671 percent.
    Canadian treasury bills and government bonds were
outperforming their U.S. counterparts. The spread between what
Canadian and U.S. three-month T-bills yield narrowed to 78 basis
points from 82 basis points on Tuesday, as investors demanded
less of a premium to lend to Canada.