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Wednesday, March 09, 2005

By Cameron French

TORONTO (Reuters) - The Canadian dollar charged to its highest level in nearly two months on Wednesday, as strong gold and oil prices kept a shine on the currency, while the U.S. dollar fell hard on trade-related worries.

Domestic bond prices fell sharply, but outperformed plunging U.S. treasuries, widening short-term U.S.-Canada spreads and pushing the Canadian 30-year yield below its U.S. counterpart for the first time in years.

The Canadian currency finished at C$1.2055 to the U.S. dollar, or 82.95 U.S. cents, up sharply from C$1.2144 to the U.S. dollar, or 82.34 U.S. cents, at Tuesday's close.

While the U.S. currency's decline was broad, Canada led the charge higher, which some attributed to surging commodity prices drawing funds to Canada's resource-heavy economy.

But others pointed out the Canadian dollar was making up for its weak performance in recent sessions, while the greenback has suffered from worries over the size of the U.S. current account deficit.

"Canada's been a bit of a leader for the past couple of days, but we've been lagging for a while, so it's playing a bit of catch-up. Certainly the market's quite negative on the U.S. dollar," said Steven Butler, director of foreign exchange at Scotia Capital.

The U.S. dollar has been a steady sell since last week's jobs data, and concerns that U.S. trade data could miss the mark when it's released on Friday have accelerated the decline, allowing the loonie to rise 2 percent in two days.

The currency popped as high as C$1.1997 to the U.S. dollar, or 83.35 U.S. cents before hitting resistance, and analysts say it could go well past that level -- some are eyeing the January high of C$1.1950, or 83.68 U.S. cents -- before Friday's data.

In addition to the U.S. figures, Canadian January trade data and February job numbers will be released on Friday.

"I think in the next day or two before we see the data, I think we've got a chance to touch that level (C$1.1950). It's already come so far in a week, I'm not sure that we're going to get that far, but I wouldn't rule it out," said Butler.

BONDS FOLLOW U.S. SHARPLY LOWER

Canadian bonds fell steeply, giving back some of their early-year gains, but trailing U.S. treasuries, which plunged on heightened U.S. inflation worries.

In its beige book summary of economic conditions, the U.S. Federal Reserve hinted of potential inflation pressures, which renewed concerns that the U.S. central bank might quicken the pace of interest rate increases.

Bonds, which had already been declining, fell further on the news.

"Basically, what we're seeing is a lot of the reversal of the massive rally we saw earlier this year, almost around the world, particularly in very long-term yields. That part of the curve is probably the most vulnerable to any renewal of inflation concerns," said Doug Porter, senior economist at BMO Nesbitt Burns.

Bonds have surged on both sides of the border as tepid economic data has defused earlier concerns about inflation pressure. But the gains have been steeper in Canada, where the Canadian dollar's sharp 2003-2004 has taken much of the steam from the economy.

This has reversed Canada's yield spread over the United States. While the spreads on the Canadian two-year and ten-year bonds have already pulled below their U.S. counterparts, Wednesday marked the first time in years that the 30-year yield spread reversed.

The two-year bond fell 8 Canadian cents to C$100.46 to yield 2.974 percent, while the 10-year bond fell 66 Canadian cents to C$104.97 to yield 4.340 percent.

The yield spread between the two-year and 10-year bond moved to 136.6 basis points from 132.8 at the previous close.

The 30-year bond, due 2029, dropped C$1.29 to C$114.93 to yield 4.780 percent. In the United States, the 30-year treasury yielded 4.817 percent.

The three-month when-issued T-bill yielded 2.48 percent, up from 2.47 at the previous close.

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