After the worst annual start in more than four decades forCanada's dollar, recent moves by the nation's money managerssuggest it may be about to turn around.

TD Asset Management, which oversees Canada's second-biggest bondfund; Sprott Asset Management LP; and Franklin Bissett InvestmentManagement say they're putting on hedges that would protect againstthe currency strengthening. That marks a switch from earlier in theyear, when they unwound, or let lapse, positions in futurescontracts or swap agreements as the local dollar plummeted versusits U.S. counterpart.

Investors are not ready to bet on further depreciation after theBank of Canada noted last week that inflation and economic growthhave been stronger than forecast as policy makers kept interestrates at 1 percent. Year-end forecasts have stabilized, afterjumping to C$1.12 per U.S. dollar in the middle of February, fromC$1.08 at the end of last year.

“We had no hedges on for a considerable period of time, and wehave recently re-established our Canadian dollar hedges,” RobertPemberton, head of fixed income at TD Asset Management, a unit ofToronto-Dominion Bank, said by phone. “The Bank of Canada is likelyto maintain a very accommodative stance over a considerable periodof time, and I don't foresee a change in rates in the nearfuture.”

At the same time, speculators and hedge funds have reducedwagers for further declines in the currency from the third-biggestshort position on record.

The most recent data from the Washington-based Commodity FuturesTrading Commission (CFTC) show bets for the currency to declineoutnumbered those for it to rise by 61,096 contracts on March 4.That net-short position is down from 70,327 on Jan. 24, which wasthe third biggest negative imbalance on record.

“Positioning is still pretty underweight Canadian dollar, so inthe near term you should probably see range-bound markets in thecurrency,” Michael Craig, a fixed-income money manager at Sprott,said in a Feb. 28 phone interview. “Just because of positioning andexpectations getting ahead of it, I think you've got to dial backyour short Canadian dollar positions.”

Craig said he reintroduced hedges protecting his U.S. dollarholdings from Canadian dollar strength at the end of last month,though he reduced them a little after last week's data showingCanada lost jobs in February.

Reducing Profits

Foreign-exchange hedges are meant to prevent unfavorablecurrency movements from eating into profits on investments such asfixed-income securities. A Canadian investor hedges U.S. holdingsby initiating bets that pay off when the local dollar rises againstits U.S. peer, offsetting the corresponding decline in thegreenback assets' value when they're converted into the Canadiancurrency.

The downside of these hedges is that they also cancel out thebenefits of a rising U.S. dollar, which inflates U.S. profits whenthey're brought back to Canada.

Investors such as Pemberton did without this protection at thebeginning of the year in a bet that Canada's dollar would decline.In January, the currency fell 4.5 percent in its worst start to ayear since at least 1972.

Triggering January's decline were bets the central bank wouldlower interest rates after it forecast inflation would stay nearthe bottom of its 1 percent-to-3 percent target band and flaggedthe strong currency as a headwind to exports.

The Canadian dollar has stabilized since, as the Bank ofCanada's latest statement dropped the mention of a strong currencyand noted that the latest readings on economic growth and inflationwere stronger than expected. Worse-than-forecast jobs numbers lastweek kicked off two straight days of declines.

The loonie, as the currency is known for the image of theaquatic bird on the C$1 coin, fell to C$1.1224 per U.S. dollar onJan. 31, the weakest level since July 2009, and was at C$1.1129 asof 9:30 a.m. in London. One loonie buys 89.86 U.S. cents. Thecurrency is the worst performer among 16 major peers against theU.S. dollar this year, dropping 4.6 percent.

It's forecast to weaken to C$1.12 by July and remain at thatlevel through the second half of the year, according to the medianestimates in Bloomberg surveys of economists.

The loonie is at about fair value at these levels, though it maystrengthen as economic growth causes speculators to abandon bearishbets, Pemberton said Feb. 28.

'Escape Velocity'

Wagers for the Canadian dollar to decline were, in part, basedon accelerating U.S. growth, which has been mixed. Since thebeginning of the year, the world's largest economy has seen data ongross domestic product, manufacturing activity, and retail salesall come in below analysts' expectations, though the latest jobsreport beat forecasts.

“The current exuberance from the U.S. dollar strength may be alittle overdone,” Darcy Briggs, a fixed-income manager who helpsinvest C$4 billion at Franklin Bissett, said by phone Feb. 28 fromCalgary. The theory that “the U.S. economy has achieved escapevelocity is proving a little more elusive than the consensus and alot of market participants thought at the beginning of theyear.”

That means the Canadian currency is as likely to rise fromcurrent levels as it is to fall, which has led Franklin Bissett tore-establish some of its hedges on its U.S. dollar investments,Briggs said.

“Our base-case scenario is the macro data out of Canada is notas dire as the foreign-exchange market had thought,” he said.“Foreign-exchange markets haven't adjusted to that.”

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