Currency movements could matter this year, given global money managers’ and strategists’ recommendations to increase exposure to foreign equities. Some suggest overweighting European and Japanese equities and underweighting those in the U.S., solely for currency reasons.

Some even suggest hedging U.S. investments back into Canadian dollars — but you need to be pretty sure the loonie will rise before you do that. And there’s no consensus among economists on which way the C$ will go, or by how much. But most analysts agree the U.S. dollar will go down against the euro and the yen.

Forecasts for the C$ range from US79¢ to US94¢. The loonie ended 2006 at US86.8¢.

Downward currency movements enhance returns in the home currency, while upward moves shrink returns. If a U.S. investment earns an 8% return in the next 12 months and the C$ appreciates 8.3% to US94¢, there will be a loss in C$ terms of 0.3%. In that case, hedging the investments back into loonies would have been an excellent idea.

However, if the loonie goes down 9% to US79¢, the 8% return on U.S. securities increases to 17% in C$ — and you’d kicking yourself if you had hedged your currency exposure in those investments.

That’s why or, at least, partly why many money managers and strategists suggest overweighting non-North American equities.

Most analysts believe the US$ has further to fall, pointing to the U.S. current account deficit, which is now more than US$800 billion. The only way to get the deficit down is for U.S. exports to grow at a much faster pace than imports. The easiest but most painful way to achieve this is to have a recession. But that’s not desirable, and only a few forecasters expect one.

A less painful cure would be a lower value for the greenback. That would bring the deficit down by increasing the competitiveness of U.S. goods, both in foreign markets and against imports at home, thereby increasing exports and curtailing the growth of imports.

As for other currencies, many strategists expect a 5%-10% appreciation in the euro. Opinion is more divided on the yen. The Bank of Japan has been aggressively entering the foreign exchange market to keep that currency from rising too much. Some analysts believe the yen will rise only if the Chinese renminbi rises because competitiveness with China matters most to Japan.

The U.S. has been applying pressure to China to appreciate the renminbi. Some upward movement has been allowed and China has a target of 3%-5% currency appreciation each year. However, the country can’t afford a big jump because of the potential for social unrest, which could occur if exports are curtailed and job growth dampened by too big a rise in the currency. The general assumption is that the renminbi will go up 5% this year, with the yen matching that rise.

China plays another important role in the currency markets through its holdings of foreign exchange. In recent years, it, along with the Bank of Japan and other Asian central banks, has been a huge purchaser of U.S. Treasury bonds, thereby providing support for the greenback.

One concern is that China and other Asian central banks will decide to diversify their foreign exchange holdings by buying euros and, perhaps, gold — resulting in a scaling back of their U.S. Treasury purchases. This would increase downward pressure on the US$, which could bring about a US$ crisis.

This is considered one of the biggest risks on the horizon in 2007, although few expect it to happen. If it did, the U.S. would be forced to raise interest rates at a time when lower rates may be required to keep its slowing economy out of recession. A jump in hedge fund activity — and the possibility of leveraged bets against the US$ — increases the risk.

The one dissenter to the view that the US$ will lose ground is Lloyd Atkinson, a financial and economic consultant based in Toronto. He thinks foreign central banks will continue to support the US$ through Treasury purchases and that foreign investors will keep buying U.S. equities.

Prospects for the C$ are clouded by debate about how sensitive it is to commodity prices, particularly oil, and about how much those prices will soften in response to a slower U.S. economy (see page B6).

@page_break@Resources play a key role in determining the value of the C$. As a major resources producer and exporter, it is Canada’s resources companies that attract the interest of foreign investors. But the euro went up as much as the C$ did in 2003-05, suggesting that downward pressure on the US$ may have played a role in the rise of the two currencies.

The euro and the yen are the two major currencies besides the greenback. Any downward movement in the US$ would be measured against those currencies. It may simply have been coincidence that oil and base metal prices were soaring at the same time as the greenback was falling. But no one really knows.

The difficulty in figuring out how close the relationship is between the C$ and resources is that even with commodity prices expected to ease this year, they will still remain very high by historical standards. So, the question is: will the easing in resources prices be enough to pull the C$ down?

Clement Gignac, chief economist and strategist at National Bank Financial Ltd. in Montreal, has one of the lowest forecasts for oil, with prices averaging US$45 a barrel in 2008. Yet he thinks the C$ will be US90¢ at the end of 2008.

Atkinson expects oil prices to be slightly higher than Gignac’s forecast, US$52 a barrel by 2008 yearend. But he believes that will be enough to push the loonie to US77¢.

The highest forecasts for the C$, at US94¢ at the end of both this year and next, are from George Vasic, chief economist and strategist at UBS Warburg Canada in Toronto. These are accompanied by oil price predictions of US$69 a barrel this year and US$62 in 2008. IE