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An employee of the Royal Canadian Mint in Winnipeg inspects coins as they come off the press.John Woods/The Globe and Mail

Only eight years ago, the loonie was flying on just one wing and a prayer when then finance minister Paul Martin and Bank of Canada governor David Dodge pitched the currency on a U.S. road show, claiming it was worth more than its lowly 62 cents (U.S.).

Today, it's perched atop global currency markets as Canada wins acclaim for its economic outlook and handling of the public debt, a point driven home Wednesday when a Russian Central Bank official confirmed that the Canadian dollar would be added to its international reserves.

While foreign interest in the loonie bodes well for Canadians who shop south of the border, it will also jolt Canada's fixed-income markets as reserve managers buy liquid debt securities with the Canadian dollars they own. And as additional countries pile into the loonie, it will only add incentive for more central banks to increase their holdings.

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"I wouldn't be surprised to see more interest in Canadian dollar reserves," said Dan Katzive, director of foreign exchange strategy at Credit Suisse in New York. "Reserve managers have accumulated too many [U.S.]dollars, they have never liked the yen, they are maybe a bit less keen on the euro than they have been in the past, and the sterling has its own potential issues."



Canada is one of the few developed countries to have successfully absorbed new stimulus debt, and last month became the first Group of Eight member to raise interest rates coming out of the recession. This strength has not gone unnoticed.

Canadian fiscal and monetary policy "continues to suggest the making of a reserve currency," said a recent BNP Paribas SA report. And on Friday, a UBS report suggested the dollar could be included in the calculation of the International Monetary Fund's special drawing rights (SDR), its unit of accounting, over the next decade. Currently, the SDR value is determined by a weighted average of the U.S. dollar, euro, yen and British pound.



Mr. Katzive does not believe the loonie will trump the greenback as the default reserve currency any time soon because of its limited liquidity, but he does think central banks and investors will increase the percentages of Canadian dollars within their portfolios, as Russia has done.

Amelia Bourdeau, director of foreign exchange strategy at UBS in Stamford, Conn., agreed. "A year ago people were saying the euro would overtake the dollar as the world's currency reserve and investors have largely changed their minds."





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With the euro no longer a viable option, she thinks the Canadian and Australian dollars are the two best choices for reserve managers who are looking to diversify.

Ms. Bourdeau also thinks it is unlikely the loonie will become a major reserve currency any time soon because the Canadian market is too small to handle the money that would be re-invested in Canada.

As the loonie became favourable over the past year, Canada saw a net inflow of $105-billion into debt securities purchased by foreigners, according to RBC Dominion Securities. Investors are "very happy to hold Canadian debt" because of limited default risk, said Matthew Strauss, senior currency strategist at RBC in Toronto.

There is considerable room for growth, too. Canada "can increase the foreign holdings almost threefold to 30 per cent and it would still be considered within acceptable levels," Mr. Strauss said.

Strong equity markets would only elevate the incentive to buy Canadian fixed-income securities because of a recent connection between the S&P 500 and the loonie.

Although Canada's export-dependent economy typically links its dollar to crude prices, since January crude has fallen 5.5 per cent while the loonie has appreciated 2.6 per cent relative to the greenback. Conversely, the S&P 500 and the dollar are moving almost in tandem.

This wasn't the case when the financial crisis exploded in the fall of 2008. After oil slumped, the Canadian dollar fell in lockstep, eventually bottoming out near 77 cents in early March, 2009.

Things are different this time around. In 2008, "no one really knew which country would come out stronger," Mr. Strauss said. Today ,Canadian fundamentals are "very, very strong," added Camilla Sutton, currency strategist at Scotia Capital. "If it wasn't for risk aversion, we'd be through parity already," she said.

This aversion is inherent in the loonie's opposition to the VIX, a measure of stock volatility. As the VIX increases, investors get nervous, pushing them to sell equities in favour of bonds and the Canadian dollar in favour of the greenback.

Although the VIX spiked in May, it is now falling as global risk subsides. The implications for the loonie look good, and Jack Spitz, managing director of foreign exchange at National Bank Financial, thinks the Canadian dollar "will outperform should equity markets stabilize."

Despite this forecast, Mr. Strauss, like Mr. Katzive, thinks SDR calculations will exclude the loonie going forward because its flow is too small. The Canadian dollar accounts for only 2.2 per cent of total foreign currency trade flow in a given day, according to the latest major trade volume report put out by the Bank for International Settlements, whereas the U.S. dollar comprises 45.1 per cent and the euro 19.4 per cent.

"Ultimately they want to keep the SDR as liquid as possible," Mr. Strauss said.

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