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Why the Loonie Is Headed South

Wednesday, 11 Jan 2012 | 3:42 PM ET
Canadian Loons
Winfried Wisniewski |The Image Bank | Getty Images
Canadian Loons

Don't look now, but the Canadian dollar could soon have its wings clipped.

You might think that bellicose talk about oil and bullish economic news from the U.S. would give the Canadian dollar a lift. After all, Canada's economy is intertwined with its southern neighbor, and with the price of oil.

Well, John Shin and David Grad, strategists at Bank of America Merrill Lynch, beg to differ.

"The Canadian dollar continues to be highly correlated with the risk environment, and as such it is highly sensitive to the market volatility stemming from Europe. We expect this situation to get worse before it gets better," they wrote in a note to clients.

Europe isn't creating the only headwinds. The strategists say Canada's housing market is overvalued, and while they don't expect a crash, "this situation may serve to exacerbate any large external shock should prices fall rapidly." China is also a concern, they say, and all these factors boost the odds of an interest rate cut by the Bank of Canada, which would hurt the loonie.

Shin and Grad think the dollar could move to 1.09 against the Canadian dollar by the end of the first quarter before retreating later in the year.

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