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Tuesday August 26, 2008 - 23:03:48 GMT
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Forex Market News - Canadian dollar climbs with oil prices, bonds rise

Tue Aug 26, 2008 5:09pm EDT

By John McCrank

TORONTO (Reuters) - The Canadian dollar rose against the U.S. dollar on Tuesday as Hurricane Gustav's potential to disrupt production lifted oil prices, supporting the commodity-linked currency.

Domestic bond prices, with no Canadian data to key off, rose after speech by a deputy governor of the Bank of Canada, which some in the market saw pointing to interest rate cuts down the road.

The Canadian dollar closed at C$1.0484 to the U.S. dollar, or 95.38 U.S. cents, up from C$1.0509 to the U.S. dollar, or 95.16 U.S. cents, at Monday's close.

Early in the session, the currency fell to a low of C$1.0563, or 94.67 U.S. cents, as the price of U.S. crude oil weakened below $114 a barrel.

But oil moved back above $116 as Hurricane Gustav looked set to head into the Gulf of Mexico, home to a quarter of U.S. oil production. Most weather models showed Gustav entering the Gulf by early Sunday.

Oil is seen as important to Canada's terms of trade as Canada is the biggest supplier of oil to the United States, and its oil sands represent the biggest deposits of crude outside the Middle East.

Rising oil prices were credited with a big chunk of the Canadian dollar's nearly 60 percent rise between 2002 and 2008. Lately, however, the relationship has been less predictable, as many analysts believe much of the recent strength in oil has been driven by speculation.

"There may be a little more substance behind this rally, given Hurricane Gustav," Matthew Strauss, senior currency strategist at RBC Capital Markets, said.

This week will be a quiet one for Canadian data, with the main event coming Friday, when the government releases gross domestic product for the second quarter. That will also be the last major piece of data before the Bank of Canada makes its September 3 rate announcement.

Analysts, on average, expect second-quarter GDP to come in at 0.7 percent, according to a Reuters poll.

In the first quarter, GDP shrank by an annualized 0.3 percent. The technical definition of a recession is two back-to-back negative quarters.

In a speech in Windsor, Ontario, Bank of Canada Deputy Governor David Longworth said second-quarter GDP would likely be somewhat weaker than the 0.8 percent annualized growth the bank had projected, based on recent data.


Canadian bond prices rose after Longworth's speech, which was seen by some in the market as supportive to lower interest rates sometime down the road.

"The bottom line is that this speech is consistent with our view that the BoC will pass on rate changes next Tuesday, but is turning somewhat more dovish in a manner that could pave the way for further easing," said Derek Holt, an economist at Scotia Capital, in a note.

But Eric Lascelles, chief economics and rates strategist at TD Securities, said there wasn't much in the speech that the market didn't know already.

He said some of the rally in Canadian bonds may have stemmed from investors playing catch up with the larger U.S. market, which has been outperforming in the past couple weeks.

Canadian bonds have fallen behind 18 basis points on the two-year yield in the past two weeks, even after taking into account Tuesday's gains.

The two-year bond rose 10 Canadian cents to C$99.82 to yield 2.832 percent. The 10-year bond added 28 Canadian cents to C$105.83 to yield 3.537 percent.

The yield spread between the two-year and 10-year bond was 79.5 basis points, up from 68.9 at the previous close.

The 30-year bond climbed 33 Canadian cents to C$116.88 for a yield of 4.006 percent. In the United States, the 30-year treasury yielded 4.439 percent.

The three-month when-issued T-bill yielded 2.49 percent, down from at 2.52 percent the previous close.

(Editing by Jeffrey Jones)

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