Canada’s Dollar Trades at Parity for First Time Since July 2008

Canada’s dollar was worth more than the U.S. currency for the first time since July 2008 on the back of the rising price of crude oil and the prospect of higher interest rates.

Canada’s dollar, dubbed the loonie for the aquatic bird on the C$1 coin, last traded at par with the greenback on July 22, 2008, 11 days after crude, the country’s biggest export, reached a record $147.27 a barrel. Oil traded near a 17-month high.

“It’s a perfect storm for the Canadian dollar,” Jonathan Gencher, director of foreign exchange sales at Bank of Montreal in Toronto. “Canadian rates are higher and Canada will be moving before the Fed. Oil is higher. The fundamentals suggest we’ll hang around here for a while.”

The currency gained as much as 0.3 percent to C$99.92 per U.S. cents, and traded at C$1.0001 at 10:19 a.m. in Toronto, compared with from C$1.0022 yesterday. One Canadian dollar buys 99.98 U.S. cents.

The loonie traded on a one-for-one basis with the U.S. currency in September 2007 for the first time in three decades, capping a five-year run on the back of booming demand for the nation’s commodities.

Canada, the largest trading partner of the U.S., has benefited from rising demand for copper, gold, wheat and oil from the U.S. and emerging economies such as India and China. The country is the world’s largest producer of uranium, the second-biggest exporter of natural gas, and sits on the largest pool of oil reserves outside the Middle East. Canada is also the world’s second-largest exporter of wheat.

Interest Rate Expectations

The strengthening Canadian currency makes it cheaper to import materials priced in U.S. dollars, according to Duncan Reith, senior vice president of merchandising in Toronto at Canadian Tire Retail, the nation’s largest auto parts and sporting goods retailer. “It’s helping us provide better value to our customers because we buy a lot of our product in U.S. dollars from the Pacific Rim,” Reith said.

Crude oil for May delivery was little changed at $86.70 a barrel on the New York Mercantile Exchange, after reaching the highest closing price yesterday since Oct. 8.

The central bank will boost its target overnight rate by 2 percentage points to 2.25 percent by the middle of next year, according to the weighted average of eight economists in a Bloomberg News survey of economists.

The six-month overnight index swap rate, a measure of the average overnight rate expected by traders during that time, rose to 0.5150 percent, near the highest level in more than a year. The central bank next meets on April 20 to determine monetary policy.

Deficit Projection

Canadian employers added 25,000 jobs in February, the third straight monthly gain, according to the median of 21 forecasts in a Bloomberg survey. Statistics Canada releases the report on April 9 at 7 a.m. in Ottawa.

Canada is on course to be the first Group of Seven nation to erase its budget gap after the global financial crisis. Finance Minister Jim Flaherty presented on March 4 a budget that forecasts the budget deficit narrowing to C$1.8 billion in 2014 from a record C$53.8 billion last year.

Fed Finds Record-Low OECD Inflation as ECB Shows Convergence

Federal Reserve Chairman Ben S. Bernanke and European Central Bank President Jean-Claude Trichet can’t afford to let the economic recovery distract them from the danger of falling into a deflationary morass akin to Japan’s.

Core consumer prices, which strip out volatile food and energy costs, rose a record-low 1.5 percent in February from a year earlier in the 30 countries that form the Organization for Economic Cooperation and Development. Goldman Sachs Group Inc. economists see core inflation falling further later this year to about 0.3 percent in the U.S. and 0.2 percent in the euro area.

The disinflationary trend is driven by the slack built up during the global economic slump. The 1.9 percent growth in OECD economies that the Paris-based organization forecasts for 2010 still will leave their total output for the year 4.1 percent below potential. With that much excess capacity, companies will remain under pressure to cut prices to keep customers and reduce costs to bolster profit.

Policy makers have “gotten their eye off the immediate ball, which is deflation risk,” said Joseph Gagnon, a former Fed official who is now a senior fellow at the Peterson Institute for International Economics in Washington. “It’s misguided for anybody to be talking about exiting” from stimulus during the next year.

Investors can profit from slowing inflation by selling Treasury Inflation-Protected Securities, Michael Vaknin, global fixed-income strategist for Goldman Sachs in London, said in a March 29 note to clients. The gap between yields on Treasuries and so-called TIPS due in two years, a measure of the outlook for consumer prices, stood at 1.56 percent on April 5, down from 2.92 percent on June 16, 2008.

Yield Curve Flattening

Vaknin also sees the U.S. Treasury yield curve flattening as long-term rates fall in tandem with inflation. The difference between yields on two and 10-year Treasury notes was 281.6 basis points on April 5.

Falling core inflation “suggests an on-hold type of stance for longer than was presumed in the past,” Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co., said in a March 25 interview with Tom Keene and Michael McKee on Bloomberg Radio. “And it does suggest, in terms of inflation currently, that bonds are a decent type of investment.”

Even so, bonds “have seen their best days,” Gross said, because, on an inflation-adjusted basis, interest rates are rising “rather dramatically” as the U.S. and other nations issue debt to cover large budget deficits and the Fed ends its mortgage buying and aid to the asset-backed securities market.

Bernanke Persuasion

Traders in the Chicago federal-funds futures market are betting there’s about a 52 percent chance Bernanke will persuade his colleagues to raise the benchmark interest rate to 0.5 percent or higher from near zero at the central bank’s Sept. 21 meeting.

Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York, and Ethan Harris, head of North America economics at Bank of America-Merrill Lynch Global Research in New York, disagree. They don’t see the Fed changing the rate banks charge each other for overnight loans for the rest of this year.

Trichet’s ECB Governing Council convenes April 8 as Mark Wall, Deutsche Bank AG’s chief euro-area economist, and Janet Henry, HSBC Holdings Plc’s chief European economist, scrap forecasts for the refinancing rate to be raised this year from a record-low 1 percent. Both now expect the first increase since July 2008 to come next March.

‘Stay on Hold’

Major central banks “are going to stay on hold longer than otherwise, keeping zero rates or near-zero rates at least to the middle of next year,” Nouriel Roubini, a New York University professor and chairman of Roubini Global Economics LLC in New York, said in an interview.

Two years from now, “with core inflation well below target, a number of central banks will be in the odd position of seeking to boost inflation,” Harris said.

As Japan has learned to its cost during the last decade, deflation can be debilitating for an economy and difficult to escape. Faced with falling prices for their products, companies are unlikely to expand operations or add workers. Consumers are prone to delay purchases, hoping for better deals in the future.

Central banks can’t easily respond, because falling prices push up interest rates in real, inflation-adjusted terms, further reducing the willingness of businesses and households to borrow and spend.

Dow Chemical

Dow Chemical Co., the largest U.S. chemical maker, reported Feb. 2 that the prices it received on products sold worldwide in the fourth quarter of 2009 were 6 percent less than a year ago. Prices fell 17 percent for the full year, the Midland, Michigan- based company said.

Paris-based Lafarge SA, the world’s-biggest cement producer, said Feb. 19 that it expects its prices will fall in Spain as it anticipates a drop in sales volume there of as much as 15 percent.

Core consumer prices in the U.S. climbed 1.3 percent in February from a year ago, the smallest increase in six years, Labor Department data show. In the three months through February, they rose at an annualized rate of 0.1 percent.

Prices on 45.2 percent of the products and services covered by the government’s personal-consumption-expenditure price index -- everything from desktop computers to parking fees -- fell in February, according to calculations by the Federal Reserve Bank of Dallas.

‘Very Benign’

“The inflation data’s been very benign,” said Carl Lantz, head of U.S. interest-rate strategy in New York at Credit Suisse Group AG. “There’s not much indication from the TIPS market that there’s a longer-term inflation risk.”

Some European countries are already flirting with deflation after property bubbles burst, complicating the ECB’s ability to set a uniform monetary policy across 16 nations. Consumer prices in Ireland fell 2.4 percent in February from a year earlier on an EU harmonized basis, the 12th consecutive decline. They dropped seven times in Spain and 10 in Portugal during the past 12 months for which data is available.

While that may allow those economies to pivot toward greater external demand by making their goods more competitive, the risk is lower prices will hurt more than help by forcing up real wages and the cost of servicing debt, said Eoin O’Callaghan, an economist at BNP Paribas SA in London. He predicts falling prices will spread, and the euro-area’s core rate will be declining by next March after slowing to a record 0.8 percent this February.

Greatest Risk

Spyros Andreopoulos, a Morgan Stanley economist in London, says inflation, not deflation, poses the greatest risk now. Emerging markets including China and India are rebounding, central banks created a record amount of monetary stimulus, government debt is mounting and the recession undermined the productive capacity of economies, leading to lower output gaps than many people realize, he said.

“We might see inflation sooner than commonly anticipated,” Andreopoulos said. Morgan Stanley predicts the Fed will raise its key rate in the third quarter, with the ECB following in December.

Among developed economies, Canada already may be facing the challenge of inflation after its core rate unexpectedly accelerated in February by 2.1 percent. Bank of Canada Governor Mark Carney, whose economists in January predicted the core measure wouldn’t reach 2 percent until the third quarter of next year, signaled March 24 he’s open to raising his benchmark interest rate as soon as June from 0.25 percent.

Inflation Expectations

The threat elsewhere is that as prices sag, inflation expectations follow, prompting consumers and companies to retrench. Such a shift may fuel a deflationary spiral similar to the one that has plagued Japan, where the economy last year shrank to 474.2 trillion yen ($5.02 trillion), without accounting for price changes, the lowest level since 1991.

Japanese prices excluding food and energy fell 1.1 percent in February after a 1.2 percent drop in both January and December, the biggest since the government began keeping records in 1971.

The Bank of Japan last month doubled a credit program for commercial lenders to 20 trillion yen, a move Governor Masaaki Shirakawa said is aimed at lowering borrowing costs further to spur growth and prices. Its policy board meets today and tomorrow.

While global inflation also slid after recessions in the 1970s and 1980s, JPMorgan’s Kasman says what’s different this time is the “prospect for record-low levels of developed-world core inflation during the first year of an economic expansion.”

“Japan’s experience provides a cautionary tale of the damage that can be wrought if deflation takes hold,” said Kasman, a former economist at the Federal Reserve Bank of New York. “The current environment poses a unique challenge for central bankers.”

Treasury Yield Rise Slowed as Currency Reserves Grow

The fastest growth in global currency reserves since the credit crisis is blunting a rise in Treasury yields even as concern increases about record U.S. borrowing to finance an unprecedented budget deficit.

Worldwide reserve assets climbed 18 percent to $7.8 trillion in the 12 months ended in March, the biggest increase since the collapse of Bear Stearns Cos. in March 2008, according to data compiled by Bloomberg. Bank of America Corp. and Royal Bank of Scotland Group Plc forecast that growth in reserves, led by Asian nations, will sustain demand as Greece’s fiscal woes raise concern about the risk of holding sovereign debt and corporate bonds offer the slimmest yield premiums over Treasuries since November 2007.

The Obama administration is counting on foreign investors, who own half of the outstanding $7.4 trillion in marketable Treasury debt, to continue buying while the Federal Reserve begins a shift in monetary policy. Former Fed Chairman Alan Greenspan and Pacific Investment Management Co.’s Bill Gross have said that yields will rise, lifting borrowing costs and reducing demand for Treasuries, as the U.S. borrows record amounts to support an economy emerging from the worst contraction since the 1930s.

“If you go into Treasuries you’ll be winning because of the rising dollar, even if yields rise,” said Christoph Kind, head of asset allocation at Frankfurt Trust in Frankfurt, which manages about $20 billion. “There was a lot of speculation about Asia diversifying away from the dollar, but I think there is a bit of frustration from what happened to the euro after the Greek crisis.”

Dollar Market Share

The U.S. dollar’s share of global currency reserves rose to 62.1 percent in the fourth quarter of 2009 while the euro’s share dropped to 27.4 percent, the International Monetary Fund said March 31 in a quarterly report. The two-year Treasury yield rose 0.19 percentage point to 1.14 percent and the dollar advanced 2.2 percent to $1.4321 per euro during the period.

Interest-rate futures traded at the CME Group exchange show that expectations for an increase in the central bank rate by November have risen to 71 percent from 62 percent a month ago. Of the 18 primary dealers that serve as counterparties to the Fed in open market operations, 10 are forecasting an increase in the central bank’s target rate by the end of the year.

International Reserves

Global reserves rose 10 percent to $8.09 trillion in 2009, IMF data show. Bank of America and RBS Securities forecast worldwide reserve growth to lead to increased demand for U.S. assets including Treasuries as investors seek markets where securities are most easily traded.

“A lot depends on what China does, but based on what we’ve seen so far I think you have to think reserves are going to grow something on the order of 5 to 10 percent globally,” said Robert Sinche, chief strategist at Lily Pond Capital Management LLC in New York.

History suggests foreign investors including China, the largest U.S. creditor, will be buyers as the narrowing advantage in yield on investment-grade corporate debt or mortgage-backed securities makes Treasuries more attractive. China’s largest increases in purchases have come during the month where the 10- year Treasury yield peaked in three of the last four years.

Yields on 10-year notes, the benchmark for everything from mortgages to corporate bonds, reached 4 percent yesterday for the first time since June. At the same time, data last month showed that foreign holders added Treasuries for a ninth consecutive month as the global economy recovered. The U.S. will sell $2.43 trillion of notes and bonds this year, according to 10 primary dealers in a Bloomberg News survey.

Currency Manipulation

A portion of China’s Treasury purchases have been made in order to maintain the linkage of the value of its currency, the yuan, with the dollar. China tightened the relationship in July 2008 as the financial crisis worsened after allowing the yuan to float within a band in July 2005.

Treasury Secretary Timothy F. Geithner said April 3 that the U.S. would delay a report on global currency policies scheduled for April 15, and urged China to move toward a more flexible currency. The decision came days after Chinese President Hu Jintao announced plans to visit Washington for a nuclear summit April 12-13.

Geithner faces demands from Congress to label China a currency manipulator for keeping the value of the yuan little changed from about 6.83 to the dollar for almost two years.

‘Huge Overhang’

Bond dealers forecast the yield on the 10-year note will climb to 4.2 percent at the end of this year, according to the median estimate in a survey by Bloomberg News. That’s still lower than the 5.46 percent average over the last 20 years. The yield declined 4 basis points to 3.95 percent at 10:36 a.m. in New York, according to BGCantor Market Data.

“Bonds have seen their best days,” Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co., said in a March 25 interview with Tom Keene on Bloomberg Radio from Pimco’s headquarters in Newport Beach, California.

Higher yields are the “canary in the mine,” Greenspan said in a March 26 interview on Bloomberg Television’s “Political Capital With Al Hunt.” The increases reflect concern over “this huge overhang of federal debt which we have never seen before,” he said.

Yield Spread

The difference in yield between Treasuries and investment grade corporate bonds has narrowed to 1.59 percentage points, the lowest since November 2007, from a high of 6.56 percentage points in November 2008, according to Bank of America Merrill Lynch index data. Mortgage spreads have narrowed from 1.92 percentage points in December 2008 to a yield 0.02 percentage point below Treasuries in November as the Fed ended its $300 billion program of Treasury purchases while continuing its $1.25 trillion operation to buy mortgage securities. The buyback of mortgages was completed last week.

China bought $114.3 billion of Treasuries in June 2009, the month the 10-year Treasury yield touched 4 percent; $69.8 billion in June 2007, when the yield hit a five-year high of 5.32 percent; and $47.8 billion in June 2008 as the yield reached 5.25 percent.

“They are buying when the market is weak,” said Michael Cheah, who manages $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey, and is a former official at Singapore’s central bank.

China may widen the yuan’s trading band against the dollar in the second quarter to as much as 2 percent, up from 0.5 percent, allowing the currency to resume appreciation to help curb inflation, according to UBS AG.

Geithner on China

The U.S. strategy is “designed to increase the odds that China does decide to do what’s in their interest, which is to let their currency start to move up again, and that’ll be part of making sure we have a more healthy global recovery in place,” Geithner said during an April 2 interview with Bloomberg Television in New York.

Treasury purchases may continue should China allow its currency to appreciate because “when the private sector realizes that Asian currencies will be allowed to appreciate capital flows might increase,” said Stephen Jen, managing director of macro and currencies, BlueGold Capital Management LLP in London. “It’s not clear whether reserve accumulation will be more or less with more currency movement. Asian central banks will still need to be major purchasers of U.S. assets in the order of what we’ve seen in recent years.”

‘Out the Curve’

China increased its holdings of notes and bonds in January while letting a portion of its record bill holdings acquired during the financial crisis mature. Notes and bonds owned by China rose 0.8 percent to $831.4 billion, while bill holdings dropped 17 percent to $57.6 billion, according to the latest Treasury Department data.

Japan, Switzerland, India and Canada have also been buying Treasury notes and bonds even as their positions in Treasury bills maturing in a year or less have declined. Foreign investors’ holdings of bills reached a peak at $607.3 billion in August and have since declined 16 percent to $508.5 billion, Treasury data show.

Foreign investors in Treasuries are taking increasing amounts of interest-rate risk on the debt rather than seeking out higher yields with corporate bonds as some concerns remain that U.S. policy makers led by President Barack Obama and Federal Chairman Ben S. Bernanke have not cleared the final hurdles in efforts to stabilize the economy, said Priya Misra, head of U.S. rates strategy at Bank of America in New York.

“You’ve seen the healing of the credit markets, issuance has come back in credit,” Misra said. “We all would have all expected them to move into spread product. Instead it’s moved out the Treasury curve.”

Philadelphia Sells Debt as Muni Issuance Rises From Low of 2010

Philadelphia and Illinois are scheduled to join municipalities issuing a combined $5.1 billion of bonds this week as sales rebound from the slowest week of the year.

State and local governments sold $4.4 billion of debt last week, the least since December, according to data compiled by Bloomberg. Yields on most tax-exempt maturities rose the past two weeks, with the 10-year touching an almost nine-month high, according to Municipal Market Advisors. Rates on taxable Build America Bonds climbed the past three weeks and are close to the highest in two months.

Build America debt, created last year as part of the federal economic stimulus package, accounted for $26 billion of the $97 billion of municipal sales in the last three months, according to Bloomberg data. Issuers of the debt get a 35 percent subsidy toward interest costs.

“The demand on the taxable side is extremely large,” said Christopher Mier, a municipal strategist at Chicago-based Loop Capital Markets. “You’re drawing in every type of taxable buyer, including foreign financial institutions.”

International investors bought 30 percent of California’s $3.4 billion taxable sale in March. Foreign buyers boosted their U.S. municipal holdings by about 50 percent, to $60.6 billion, in 2009, according to Federal Reserve data.

The average yield on the Wells Fargo Build America Bond Index was about 6.31 percent on April 2, 1 basis point below a two-month high of 6.32 percent set March 25. A basis point is 0.01 percentage point. Top-rated, 10-year tax-exempt securities yielded 3.23 percent, the highest since July, according to a daily survey by Concord, Massachusetts-based MMA.

‘Timing Is Good’

Illinois will offer $356 million in taxable debt this week, including Build America Bonds. The securities are part of $1.056 billion of debt that will help rebuild transportation and school infrastructure, said John Sinsheimer, Illinois director of capital markets, in an interview.

“We think the timing is good,” Sinsheimer said. “The market is understanding the Build America Bonds; they’re attractive to foreign investors.”

This week’s issuance calendar, which will include $4.2 billion in tax-exempt bonds and $895.6 million in taxable debt, still ranks among the three slowest this year. Diminished supply will help buoy the muni market, said Alan Schankel, a managing director at Janney Montgomery Scott LLC in Philadelphia.

“There’s going to be some decent demand and not much supply, and you could start to see muni yields outperforming” Treasuries, he said.

Reduced Supply

Ten-year municipal debt yields about 83 percent of equivalent-maturity Treasuries as of last week, up from this year’s low of about 79 percent, touched in January, according to Bloomberg data. Municipal yields have dropped in part as issuers turned to Build America Bonds, reducing tax-exempt supply. The government subsidizes part of the interest if states and local governments use the taxable bonds for public works.

Fitch Ratings will begin to shift its municipal grading scale today to make the ratings more comparable with corporate debt. State and local general obligations rated A to BBB- will be adjusted two levels higher and those rated A+ or more will be raised one level, the company said last week. Moody’s will begin doing so later this month.

“People that won’t buy anything rated below A are going to have more choices,” Schankel said. “This will help munis and perhaps lower overall yields a little bit, even though it’s not technically a credit improvement.”

Philadelphia, the lowest-ranked city among the 10 most- populous in the U.S., will offer $391.3 million in tax-exempt revenue bonds. The issue will be used to refund prior debt owed by the city’s water department.

Following are descriptions of pending sales of municipal debt in the U.S.:

THE CONVENTION CENTER AUTHORITY OF NASHVILLE AND DAVIDSON COUNTY plans to sell $633.3 million in bonds this month to help fund a new convention center in the capital city. The securities will be backed by tourism tax revenue. The issues will mature from 2019 through 2043. Goldman Sachs Group Inc. will market the sale. The bonds are rated Aa3 by Moody’s, A+ by Fitch and A by S&P, the fourth- and sixth-highest investment grades, respectively. (Added April 5)

MASSACHUSETTS DEPARTMENT OF TRANSPORTATION, created last year in a merger of state agencies, plans to sell $592.3 million of variable-rate demand obligations as soon as this week to match an interest-rate swap tied to its debt, according to a preliminary official statement. It sold $261.2 million of fixed- rate securities to lower its borrowing costs this week. The bonds were originally sold in 1997 and 1999 by the Massachusetts Turnpike Authority to finance Boston’s $14.9 billion “Big Dig,” the largest public works project in U.S. history. The subordinated bonds are secured by turnpike tolls and other revenue, such as state aid, and were rated AA-, fourth-highest, by Fitch on March 16. (Updated April 5)