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The Canadian dollar finally came back down to mother earth this past Monday in a blaze of glory – what with the slump in gold and oil prices and the carry trade. In fact, its swoon was the steepest since 1971. Other contributing factors included increased concerns about the global economy’s ability to withstand a U.S. slowdown, and the unwinding of the carry trade (wherein the yen strengthened against everything except the U.S. dollar).

The European Central Bank and the Bank of Canada could very well move in the direction of lower rates, whereas the U.S. Federal Reserve will keep a watchful eye on the possibility of an impending recession, in which case it would once more lower rates, further eroding the value of the greenback.

Up until recently, traders have embraced risky positions in carry trade currencies under the assumption that the U.S. economy would hang in there. But, lately there have been signs that may not be the case, and traders have been fleeing their positions. In the carry trade, traders engage in what is known as ‘arbitrage’ - the nearly simultaneous purchase and sale of foreign exchange in different markets, in order to profit from price discrepancies. This form of trading usually involves low Japanese rates, and high interest rates in other jurisdictions. It can be nerve-racking, and not for the faint of heart, as it is subject to quick reversal, should world events dictate a risk-aversion stance – as in worries about worsening U.S. economic conditions.

Dennis Gartman, an influential U.S. analyst, sees further weakness in the loonie, given the severity of its nosedive on Monday. This news is brought to you by www.forexmentor.com

Source: Globe and Mail ROB – Heather Scoffield, Nov. 13/07.

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