David Watt George Davis CMT Global FX Strategy

Senior Currency Strategist Chief Technical Analyst

RBC Dominion Securities Inc. RBC Dominion Securities Inc. 6 August 2010
+1 416 842 4328 +1 416 842 6633

CAD Pulse: CAD Performance — Location, Location, Location

Market Summary z FX Bottom-line: CAD has underperformed its highly cyclical peers (AUD, NOK and
Currencies Level 1 wk chg SEK) since mid-June. We expect modest further CAD underperformance in Q3, thanks
USD/CAD 1.0164 -0.0207 to “location effects” that are weighing on CAD, notably increased uncertainty over US
EUR/CAD 1.3395 -0.0173
GBP/CAD 1.6138 -0.0048 economic prospects and a possible cooling in the pace of Canadian job creation.
CAD/JPY 84.49 0.7800
z However, later this year, location effects will fade and CAD’s next major move against
USD/CAD RBC F Forwards its cyclical and commodity peers will be CAD bullish.
1M 1.0500 1.0168
3M 1.0900 1.0180 z Q3 CAD underperformance will present better entry levels for the next major CAD move
6M 1.0500 1.0203 versus its cyclical and commodity peers in Q4 and beyond.
CAD cash rates Level 1 wk chg (bp)
BOC target 0.75 0
1m 0.90 1 RBC’s Canadian Dollar Valuations
3m 1.05 1 Fundamentals Comment Impact on USD/CAD
6m 1.23 1
12m 1.61 1 Quarterly fair value USD/CAD is fairly valued §¨
Weekly fair value USD/CAD is fairly valued §¨
Govt bonds Yield 1 wk chg (bp)
2yr 1.52 -2
Canadian Economic Surprise Index -60 a is bullish USD/CAD ©
5yr 2.32 -6 Canadian Data Risk Barometer Bearish USD/CAD ª
10yr 3.12 -6 Market Positions and M&A Activity
30yr 3.67 -8
1-month, 25-delta risk reversals Bearish USD/CAD ª
CA-US spread (bp) Level 1 wk chg Trend M&A inflows into Canada Net inflow of US$0.2bn and is neutral USD/CAD §¨
2yr 99 2
5yr 36 14
10yr 22 2
30yr -37 -5 1. CAD commodity currency cross rates fluttering around key levels

Equity markets Level 1 wk chg AUD/CAD CAD/SEK 6.4 CAD/NOK

Canada TSX comp. 11,774 46 0.99 7.7
US S&P500 1,124 22
Source: Bloomberg 6.2
0.97 7.5

USD/CAD Options 0.95 7.3 6.0

USD/CAD volatility
(%, annualised) 0.93 7.1
Historical Implied 5.8
1w 5.39 10.24
1m 11.05 10.43 0.91 6.9
3m 15.13 11.21 5.6
6m 12.82 11.67
12m 12.62 12.24 0.89 6.7
1m R.R 1.2c
5.4
Source: Bloomberg 0.87 6.5

0.85 6.3 5.2

USD/CAD Technicals
1.0401 Short-term resistance Jun-09 Oct-09 Feb-10 Jun-10 Jun-09 Oct-09 Feb-10 Jun-10 Jun-09 Oct-09 Feb-10 Jun-10
1.0302 Old triangle bottom
1.0164 Spot
Source: RBC Capital Markets, Bloomberg
1.0141 June 21 low
0.9977 Congestive support
Source: Bloomberg

For required conflicts disclosures, please see last page. See RBC’s research at www.rbcinsight.com.
6 August 2010 Global FX Strategy: CAD Pulse: CAD Performance — Location, Location, Location

CAD Performance — Location, Location, Location

David Watt
FX Bottom-line: CAD has underperformed its highly cyclical
peers AUD, NOK and SEK since mid-June. We expect modest
further CAD underperformance in Q3, thanks to “location effects”
that are weighing on CAD, notably increased uncertainty over US
economic prospects and a possible cooling in the pace of
Canadian job creation. However, later this year, location effects
will fade and the next major move against its commodity peers will
be CAD bullish. Thus, further CAD underperformance will present
better entry levels for the next major CAD move versus its cyclical
and commodity peers in Q4 and beyond.
Location, Location, Location
CAD’s outperformed through H1, but has underperformance since
mid-June (Figure 2). In part, this reflects “location effects” from
recent events in the US. The prospect of a smooth handoff from
stimulus-led growth to private-sector led growth has been
somewhat sloppier than anticipated. Thus, the regional CAD boost
in H1 from a focus on the strength of the recovery of the US
compared to other major economies faded as the US economy hit
a rough patch, most clearly reflected in the very tepid job market
that has prompted the Fed to turn more cautious and to begin
chatting about the possible need for further easing measures,
marking a distinct change from the focus on exit strategies that
dominated Fed commentary in the first half of the year.
2. CAD — From first to worst
12/31/09 – 6/15/10 v USD (%) 6/15/10 – 8/4/1
CAD +2.7%
JPY 1.7%
NZD -3.3%
AUD -3.6%
SEK -7.7%
GBP -8.5%
CHF -8.6%
NOK -9.0%
EUR -13.9%
Source RBC Capital Markets, Bloomberg
Canadian cross currency swap spreads reinforced short-term
CAD underperformance (Figure 3) and these trends are expected
to continue so long as “location” effects remain in force. We expect
this to be the case through Q3, but to fade thereafter. In particular,
domestically, Canadian economic data, particularly employment,
is expected to cool in Q3 from the torrid pace in of job creation in
Q2, as Canada navigates the transition from recovery to moderate
expansion (RBC expects GDP growth to slow from Q1’s 6.1% to
3% in Q2). As well, the debate over the health of the US recovery
and the potential for further Fed quantitative easing seem set to
remain very active for the rest of Q3. With that backdrop CAD
cross rates (AUD/CAD, CAD/NOK and CAD/SEK) are fluttering
about key thresholds, specifically their respective 200-dma (Figure
1). The above discussion focused on modest further CAD
underperformance through Q3. Accordingly, we expect CAD to
decline by 1.5%, from current levels, against a basket of its peers
(AUD, SEK and NOK).
The Next 5% Move; Patience Pays Off
However, following this period of CAD underperformance through
Q3, we expect the next 5% move versus its commodity peers to
be CAD bullish. Through year end, RBC expects, CAD to rally by
5% versus AUD, 5.6% versus SEK and 5% versus NOK, or an
equally-weighted average CAD gain of 5.2%. Short-term CAD
underperformance will thus present better entry levels for CAD
long positions, presenting a potential 6.5% gain to year end.
These moves would consistent with the “location model”
discussed above. RBC thinks that the risk of a US double dip and
of further QE is rather low and that the US will emerge from its
current soft patch into a sustained, though modest, expansion. As
well, RBC continues to hold the view that other several other major
v USD (%)
nations face imposing hurdles to sustained expansion in the form
SEK 8.6%
of tight financial conditions or robust fiscal retrenchment. RBC thus
CHF 7.6%
expects USD to rally to year end and that regional issues will
GBP 7.3%
weigh less on CAD than on its cyclical and commodity peers.
EUR 6.7%
NOK 6.2% Hence, recent trends in AUD/CAD, CAD/SEK and CAD/NOK are
JPY 6.0% akin to retracements within a broader trend. That dominant trend is
AUD 5.8% CAD-bullish and is expected to eventually reassert itself. By year
NZD 5.1% end RBC expects AUD/CAD to be at 0.8720 (spot ~0.9330),
CAD 0.7% CAD/SEK to be at 7.345 (spot ~7.01), and CAD/NOK to be at
5.973 (spot ~5.89). The further out one looks the better the CAD
backdrop. By mid-2011, AUD/CAD is seen at 0.81, last seen in
early 2009, CAD/SEK is expected to rally to a record high of 7.91,
and CAD/NOK is expected to rise above 6.5 for the first time.
Q3 CAD weakness will be an opportunity to get better levels to buy
CAD versus AUD, SEK and NOK its cyclical and commodity peers.

3. Swap spread trends a key factor for CAD crosses with other commodity currencies
500 AU-CA 2-y r Sw ap Spread LHS 1.10 400 4.5 250 Sw ed-CA 2-y r Sw ap Spread LHS 5.5
NO-CA 2-y r Sw ap Spread LHS
AUD/CAD RHS 1.06 350
450 200 CAD/SEK (inv erted) RHS
CAD/NOK (inv erted) RHS
1.02 300 5.0 6.0
400 150
0.98
250
350 0.94 100 6.5
200 5.5
300 0.90 50
0.86 150
250 7.0
100 6.0 0
0.82
200 0.78 -50
50 7.5
150 0.74 0 6.5 -100
Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

Source: RBC Capital Markets, Bloomberg

2
Global FX Strategy: CAD Pulse: CAD Performance — Location, Location, Location 6 August 2010

BoC: More rate hikes; Fed: More stimulus? 4. BoC to remain far, far in front of Fed
Weak US data has sparked concern that the nascent recovery is 1.50 BoC OVN Target 0.75
withering away in the summer heat. There is thus a discussion that CA 3m OIS
US 3m OIS
the Fed is poised to turn on the taps once again and send a flood of 1.25 CA 6m OIS
CA 12m OIS US 6m OIS
liquidity flowing into markets. Meantime, in Canada, the market 1.00 US 12m OIS
0.50
remains well priced for the BoC to keep hiking rates, though a
pause later this year is anticipated. As the recent US soft patch 0.75
passes, and we still foresee it passing even though choppier and 0.50 0.25
less optimistic scenarios are disturbingly realistic possibilities, so
too will the discussion about another trip down quantitative easing 0.25 Fed funds
lane for the Fed. That will set the stage for some of the bearish target range (0% to 0.25%)
0.00 0.00
scenarios to be removed from market pricing, and give USD a
Jan-09 Jul-09 Jan-10 Jul-10 Jan-09 Jul-09 Jan-10 Jul-10
boost across the board, even against CAD and as BoC hikes rates.

Source: RBC Capital Markets, Bloomberg

Gone are the golden days of Canadian trade surpluses 5. CA trade balances: Two solitudes
For 392 straight months to November 2008, Canada posted trade 10 Energy Trade Balance (C$bn) LHS
surpluses. In the 18 months since, there have been 6. The June Non-Energy Trade Balance (C$bn) LHS
8
2010 data will add to the deficit count. The mixed trade balance
6
reflects the two solitudes of Canadian trade. The export sector
4
remains a trade surplus mainstay. The non-energy trade balance
has been in persistent deficit since June 2007, and that won’t 2
change soon. On the energy trade front, prices, particularly oil 0
prices, still explain much of the dynamics of the surplus. So long as -2
oil prices remain elevated, the energy trade surplus endures, -4
although it is no longer able to offset the deep non-energy trade -6
surplus. Canada won’t likely run 392 straight trade deficits, but
85 88 91 94 97 00 03 06 09
neither will consistent trade surpluses return soon.

Source: RBC Capital Markets, BoC, Haver Analytics

Bearish trend reversal for USD/CAD this week 6. USD/CAD: Parity back in view
USD/CAD underwent a shift in sentiment on August 3 when
prices pierced uptrend support at 1.0292. The resulting bearish
trend reversal increased downside risks by exposing support at
1.0141, followed by the congestion area at 0.9977. The only
headwind to the downside risks surrounds the fact that the daily
studies have just moved into oversold territory. While this may
spur a retracement phase, the recent trend reversal indicates
that price corrections to resistance at 1.0302 and 1.0401 should
attract selling interest in the current environment. We note that
prices will have to close above the triangle top at 1.0547 in
order to produce a bullish trend reversal that would nullify the
downside risks.
Source: RBC Capital Markets, Tradermade

Data Risk Barometer: Bearish USD/CAD

Aug Data/Event RBC Mkt Pre Risk *
10 Jul Housing Starts 188K 183K 192.8K ª
10 Jun New Housing Price Index m/m 0.2% 0.3%
11 Jun International Merchandise Trade -C$1.0bn -C$0.5bn
13 Jun New Motor Vehicle Sales m/m 2.0% 0.2%
Source: RBC Capital Markets, Bloomberg

3
6 August 2010 Global FX Strategy: CAD Pulse: CAD Performance — Location, Location, Location

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4
 Global FX Strategy
Adam Cole Elsa Lignos Christian Lawrence
Senior Currency Strategist Currency Strategist FX and Rates Strategy
Royal Bank of Canada Europe Royal Bank of Canada Europe Royal Bank of Canada Europe
Limited Limited. Limited.
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Sue Trinh Matthew Strauss CFA David Watt George Davis CMT
Senior Currency Strategist Senior Currency Strategist Senior Currency Strategist Chief Technical Analyst
Royal Bank of Canada, Hong Kong RBC Dominion Securities Inc. RBC Dominion Securities Inc. RBC Dominion Securities Inc.
+852 2848 5135 +1 416 842 6631 +1 416 842 4328 +1 416 842 6633

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