Canadian Dollar Versus US Dollar: Loonie Approaching Parity With USD

The Canadian dollar or the Loonie, seems all set to attain parity with the US dollar on the back of firmer oil and commodity prices, better managed government debt, and a faster recovering Canadian economy, which is suggestive of the fact that interest rates may rise earlier in Canada than in the US.

Though Canada also carries the burden of huge government debt, a hangover of the economic stimulus package implemented by the government to stave off the recession, the country seems to have managed its debt level the best amongst other economies like the US and the European Union. This puts it in an enviable position and is further leading speculators to believe that the Loonie is going to strengthen and making them invest more in it and leading to it firm up. Canada is one of the few remaining nations with the AAA tag, which could result in a switch in sovereign investment inflow from weaker rated nations to Canada. This is another reason, why the Loonie is likely to appreciate further.

On the flip side, the US has reported the largest monthly deficit ever in February, which bloated to $221 billion. The deficit for the year 2010 is expected to be around $ 1.56 trillion as against $1.4 trillion in 2009. The increasing deficit is the result of the $787 billion stimulus package announced by the government to fight the worst ever recession since 1930. However, even after the government's desperate efforts, unemployment in the US is close to 10%. Under such circumstances controlling the deficit is still a bit difficult as the US government needs to keep providing some fiscal stimulus.

At the same time it may be noted that deficits usually shoot up in February as the large refund payments to individuals and corporations as part of the tax filing process are made by the government during this month. Keeping in view the seriousness of the situation, the Obama administration has appointed an 18-member fiscal reform commission that is to devise a plan by which the deficit can be shrunk to 3% of the GDP within five years.

The problem, however, does not end at that. High level of government debt implies that government spending is crowding out private investment. This requires not only fiscal discipline on the part of the government, but also requires an easing of interest rates. However, with a large part of government spending having been pumped into the economy, high level of liquidity poses the threat of inflation in the near future.

This requires governments to raise interest rates. However, the US is not in a position raise interest rates at present due the state of its economy. On the other hand, the better state of the Canadian economy presents the opportunity to raise interest rates earlier, which can result in the Loonie getting stronger and achieving parity with the US Dollar!

However, this line of reasoning also suggests that the Canadian Central Bank may be ahead of the US only by a few quarters in raising interest rates. Once the US is in a position to raise interest rates, the US Dollar may again get ahead of the Loonie. Thus, there may be an interim opportunity for money to be made from the Loonie's movement towards parity till the time the US economy shapes up and interest rates head up in the US as well.