January 17, 2008 / 10:25 PM / in 10 years

Bleak U.S. outlook hits dollar

TORONTO (Reuters) - The Canadian dollar was dragged lower against the greenback on Thursday as a steady stream of dire U.S. economic news pointed to the growing possibility of a recession in the world’s biggest economy, which absorbs nearly three-quarters of Canadian exports.

Domestic bond prices rallied along with U.S. Treasuries in a safe-haven bid as stock markets fell heavily into the red.

The Canadian unit closed at 97.11 U.S. cents, valuing a U.S. dollar at C$1.0298, down from 97.60 U.S. cents, or C$1.0246, at Wednesday’s close.

“A few things are playing into a weakening off of the Canadian dollar today including a weakening off of oil prices, as well as disappointing economic news from the Philly Fed,” said Camilla Sutton, currency strategist at Scotia Capital.

The Philadelphia Federal Reserve Bank said its business activity index had its largest one-month drop since January 2001 in December, exacerbating fears of a U.S. recession.

That sent the U.S. dollar lower against most other currencies, and it took the Canadian dollar with it, as Canada’s economy is inextricably linked to the U.S. economy.

The painful news continued, with some U.S. earnings that surprised to the downside, sending equities markets tumbling.

Later in the day Fed Chairman Ben Bernanke confirmed his bleak assessment of U.S. economy’s health before a congressional committee further adding to the gloom in the market.

“Merely a few months ago, many analysts (including the Fed) were arguing that the contraction in housing would not spill over to the rest of the economy,” said Michael Gregory, senior economist at BMO Capital Markets

“However, the depth and duration of the contraction have now reached critical levels and an outright economy-wide recession is a real possibility.”

The Fed is expected to cut interest rates by a hefty half-percentage point at the end of the month. The market is increasingly anticipating an emergency cut of 25 basis points before then.

In Canada, a Reuters poll showed that Canada’s 12 primary securities dealers unanimously predict the central bank will announce a 25 basis point cut to 4.00 percent in its key overnight interest rate on January 22. All but one of the dealers see another 25 basis point cut in March.

Worries that a U.S. recession would hurt energy demand knocked oil prices, which had hit a record high of $100.09 on January 3, below $90.

Canada is a major oil producer and exporter, and its currency’s 60 percent run-up since 2002 was largely in line with a run-up in crude prices.

BONDS RISE

Canadian bond prices rose in response to the negative U.S. data and the havoc in the North American stock markets.

“The Philly Fed got things kicked off, but primarily the market today was focused on the financial news and the continued weakness in equities markets,” said Mark Chandler, fixed income strategist at RBC Capital Markets.

A record quarterly net loss from brokerage Merrill Lynch MER.N reawakened credit crisis fears and hammered financial stocks, sending investors towards safe haven government debt.

Domestic data showed foreigners reduced their holdings of Canadian securities by C$4.84 billion in November, but the report is not generally considered a market mover.

The last piece of Canadian data due ahead of the central bank’s monetary policy announcement is the November manufacturing shipments report on Friday.

The two-year bond climbed 7 Canadian cents at C$101.80 to yield 3.240 percent. The 10-year rose 44 Canadian cents to C$101.78 to yield 3.772 percent.

The yield spread between the two-year and 10-year bond was 53.2 basis points, unchanged from the previous close.

The 30-year bond was up 53 Canadian cents at C$116.29 to yield 4.046 percent. In the United States, the 30-year Treasury yielded 4.253 percent.

The three-month when-issued T-bill yielded 3.61 percent, unchanged from the previous close.

Editing by Renato Andrade

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