Montreal, Canada

One of the strongest currencies vis-à-vis a resurgent American dollar since December remains the Canadian dollar. Portfolio flows into Canada soared in 2009 as the country drew record amounts of institutional cash into stocks, bonds and the Canadian dollar. Real estate has also been strong with residential prices now at new all-time highs after briefly declining in 2008.

The Loonie has basically remained in a trading range since December as the greenback surges against most foreign currencies on signs of an impending economic recovery coupled by rising interest rate expectations. Even as oil prices have pulled back recently, the Loonie remains strongly bid against all major crosses.

Since December 1st the Canuck buck has declined just 0.76% versus the U.S. dollar. Other currencies have declined far more, including the EUR, down -8.7%. Losses in excess of 5% plague the Australian dollar and the Brazilian real – two of the hottest commodity-linked currencies over the last several years.

Canada is enjoying a global investment renaissance whereby investors are lunging after Canadian assets at a record pace.

Canadian banks are far stronger and adequately capitalized compared to most other Western institutions and the country’s financial services and regulatory model is widely seen as a template for G-7 banking reforms. The country’s banks largely escaped the credit crisis with the exception of a commercial paper fiasco, which resulted in small losses compared to write-downs experienced elsewhere.

But the shine may be a bit too bright on Canada…

The strong Canadian dollar continues to depress export manufacturing in Ontario and Quebec. Canada is rapidly losing export competitiveness against the United States. Nearly 40% of Canadian GDP is generated by exports – mainly to the United States.

Housing, by some measures, is now approaching bubble levels in Canada as prices have risen 23% from their trough in January 2009. Home-sales volumes are up 70% over the same period. Furthermore, The Bank of Canada recently warned that household debt – largely mortgages – was 1.42 times disposable income during Q2 2009 – a record high.

Deficits are also on the rise across the nation.

Alberta, which once sported massive budget surpluses amid soaring natural gas prices now faces deepening deficits. Last year marked the first time in years Alberta logged a budget deficit.

Other provinces also face fiscal challenges.
The country’s export belt, based in Ontario and Quebec, are hurting as the Loonie’s strength saps export leverage. A weak U.S. recovery is also a strain as both provinces heavily depend on American demand.

Canada, which recorded a string of trade and budget surpluses for years ran into deficit spending as a result of the financial crisis in 2008; the country is still mired in red ink as it tries to balance its books. Canada’s budget balance as a percentage of GDP is 2.4%, small compared to America’s 11.9% figure and 14.5% in Britain. The trade deficit, which is shrinking, remains in negative territory.

Canada is still a good place to invest. Global investors have grown fond of Canada because deficits are small relative to other countries, banks are solid and commodities remain in a secular bull market – and Canada has an abundance of raw materials. Foreigners love our bonds because our net debt is much less than most countries mired in the post-2007 credit crisis and sovereign debt escalation.

But Canada still harbors deficits. And the currency is too strong putting The Bank of Canada in a difficult position when the Americans begin tightening credit later this year or in 2011; the Loonie would only strengthen and probably break par-value again versus the U.S. dollar if interest rates rose from near zero-percent levels. The last thing Canada needs now is a stronger currency.

Longer term it’s probably a safe bet that the Canadian dollar will command a premium versus the deficit-plagued U.S. dollar. On a relative basis there’s no denying the Loonie is a sounder currency. And surging commodities are a boon for Canada, including a resource-hungry China vying for Canada’s mineral wealth. But asset prices have risen too far, too quickly and a correction is long overdue in stocks and residential housing. A rate hike would do the trick by tempering euphoria now gripping all things Canadian.