Canadian Dollar to Compound Losses as Risk Appetite Fades

Friday’s closing bell marked the end of the worst three-day stretch for US equity markets since last year’s broad-based recovery in risk appetite began in March. The VIX index of stock option volatility, a standby “fear” gauge, surged 55% over the past three days to post the biggest gain since 2007. Investors had their pick of reasons to be selling: fourth-quarter earnings reports disappointed on revenues, which would have been overlooked last year but now is far more critical now that the end of stimulus measures is on the horizon and the economic recovery must become self-sufficient; US lawmakers dithered on whether Fed Chairman Ben Bernanke, a figure the markets view a key positive force amid the 2008 financial crisis, will be confirmed for a second term; US President Obama proposed wide-reaching new restrictions on banks’ size and trading activities; and stronger-than-expected Chinese GDP and inflation figures stoked speculation that Beijing would step up efforts to restrict lending amid fears the economy may overheat.

The Canadian Dollar was not spared the carnage as the commodity bloc currencies bore the brunt of the flight from risky assets. Indeed, the Loonie’s decline over the past week was second only to that of the New Zealand Dollar. With seemingly no easy resolution to any of the issues now weighing on investor confidence, more of the same is likely ahead. Indeed, the short-term correlation between a trade-weighted index of the Canadian unit’s average value and the MSCI World Stock Index now stands at 91%, hinting at deeper losses for the currency as capital continues to pour into safe-haven investments.

November’s Gross Domestic Product reading is the only significant item on the Canadian economic calendar. Expectations call for the economy to have expanded 0.3% from the previous month, marking the third consecutive period of positive growth. However, the outcome may not prove especially market-moving considering its limited implications for monetary policy after the Bank of Canada reiterated that it plans to hold interest rates at record lows at least until June and downgraded its 2010 economic growth outlook last week.