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Canadian $ set for further gains into record territory

Blog by | November 6th, 2007

C$ set for further gains into record territory, credit worries to hamper stocks

Malcolm Morrison, THE CANADIAN PRESS

TORONTO - The loonie is cleared to takeoff to even higher levels after the Canadian dollar had an amazing run last week, blowing through 50-year-old highs against the U.S. currency on the usual suspects - a lower greenback, higher oil prices and in particular a blow out jobs report for October.

The Canadian dollar shot up as much as two cents US Friday after Statistics Canada announced that the Canadian economy created 63,000 jobs in October, much higher than the consensus of 12,000.

The employment increase dropped the official jobless rate to a 33-year low of 5.8 per cent, from 5.9 per cent in September.

"The direct response of the currency to the labour market report is not that unusual but what is unusual of course was the starting point for the currency - it's already had an unprecedented rise in the last two months, never mind the last five years," said Doug Porter, deputy chief economist at BMO Nesbitt Burns.

"It's gone from incredible strength to incredible strength."

The dollar ultimately ended Friday's session up to a record high of cents US, well past the high of 106.14 cents US set in August, 1957.

The latest surge in the dollar coupled with further evidence of a strong economy makes it increasingly difficult for the Bank of Canada to use lower interest rates to cool demand for the currency.

"Overall the Canadian economy is on quite a roll here, the labour market is tight, and wage pressures are starting to creep up so it would be fairly difficult for the Bank of Canada to cut rates any time soon," said Craig Wright, chief economist at the Royal Bank.

"A fundamental move higher in the currency is fine, when you get into the speculative side of it, which I think we're into to some degree now, then there may be some scope for the bank to offset some of that with a move but that's probably a story for next year rather than this year."

Meanwhile, stock markets look set for a down week after the U.S. Federal Reserve last Wednesday cut interest rates by a quarter point to help mitigate damage from the contracting U.S. housing sector and keep the credit crisis from spreading into the broader economy.

Initially, the cut sent markets surging close to record levels but by the end of the week the mood turned more negative, despite the strong October jobs data, as worries resurfaced about credit conditions and the strength of financial companies.

Stocks have had a tremendous runup since the Fed cut interest rates a half point in September and investors hoped the worst of the credit troubles were behind the market.

However, at week's end an analyst downgraded U.S. banking giant Citigroup to sector underperformer from sector performer, citing potential worries about its dividend payments.

And the Wall Street Journal reported that brokerage giant Merrill Lynch has engaged in deals with hedge funds to delay when it had to record losses on risky mortgage-backed securities.

It also said the Securities and Exchange Commission has started a probe looking at how Wall Street is valuing mortgage securities.

"It seems like credit market concerns, which really erupted in the summer and seemed to have faded, have never really gone away for the U.S. markets and they certainly have returned to the fore in recent days," added Porter.

The malaise also spread to the financial sector on the TSX, despite the fact that Canadian banks' exposure to troubled U.S. mortgages is minimal.

"I think the broader concern of the credit turmoil we're still living through for the economy is that it can squeeze the credit availability either directly or indirectly and I think that's the concern for economic growth and more specifically for the financial services sector generally," he said.

Also weighing on investors was the message from the Fed last week that it's done with this cycle of rate cuts since the economic data available so far indicates the damage from the housing sector is being contained.

"The standard view has been on Wall Street and elsewhere that the housing market is just so weak that there's a real risk that it spills over to the rest of the economy," said Porter.

"But so far, evidence of a serious spillover is pretty hard to find."