Will 'Fiscal Cliff' Clip the Loonie's Wings?

For a Star Currency in 2013, Look North
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Worries about potential dragonian tax hikes and spending cuts in the U.S. could derail risk-sensitive currency plays on the dollar.

What's that up ahead? Why, it looks like a cliff. A 'fiscal cliff.'

Investors seemingly woke up the morning after the election in a lather about the fiscal cliff - a package of major tax hikes and spending cuts that is on track to be implemented at the end of the year.

Ironically, the worry has lifted the dollar as its safe-haven status seems to outweigh its obvious sensitivity to U.S. fiscal policies.

The effect on risk-sensitive currencies to the south and north of the U.S. have not fared as well. And Nick Bennenbroek, head of currency strategy at Wells Fargo, thinks that pressure will continue.

"The election is now likely to pave the way for weeks of difficult budget negotiations as U.S. political leaders attempt to avoid the fiscal cliff," he wrote in a note to clients. "Over the next several weeks we expect the U.S. dollar and yen to outperform, and most foreign currencies to lose ground. The Canadian dollar and Mexican peso could be vulnerable during this period."

If you're taking the long view, however, things look better for the loonie, Bennenbroek says. "Canadian activity and inflation has eased, and with extended long FX positions and U.S. related uncertainty, the currency should decline near-term. The Bank of Canada maintains an overall hawkish bias however, and we look for the Canadian dollar to recover in 2013 as global markets improve."

The upshot: pick your time frame, and trade accordingly.



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