Canadian dollar strengthens as investors hope for debt ceiling deal

By Leah Schnurr

TORONTO (Reuters) - The Canadian dollar strengthened against the greenback on Wednesday as investors remained hopeful a deal would be reached In Washington to raise the U.S. government's borrowing limit and avoid a potential default.

U.S. lawmakers prepared for a last ditch effort to come to an agreement to raise the debt ceiling, with the borrowing authority set to run out on Thursday. The top Democrat and Republican in the U.S. Senate were said to be close to agreeing on a proposal for consideration by the full Senate later on Wednesday.

The down-to-the-wire nature of the negotiations were reminiscent of the debt ceiling debate in 2011 when a deal was reached at the last minute, and investors still believe a solution will be forthcoming this time around.

Still, Fitch Ratings on Tuesday warned it could cut the sovereign credit rating of the United States from AAA, citing the political brinkmanship citing the political brinkmanship over raising the federal debt ceiling.

This would leave Canada as one of a shrinking handful of countries with an undisputed AAA rating.

Fitch's warning on Tuesday could serve as a warning shot to U.S. politicians, said Scott Smith, senior market analyst at Cambridge Mercantile Group in Calgary.

"The markets seem to be convinced that we'll be able to get a deal hammered out before we move past this 'x-date' and really get into trouble with the potential of a technical default," Smith said.

The Canadian dollar was at C$1.0367 versus the U.S. dollar, or 96.46 U.S. cents, stronger than Tuesday's close at C$1.0380, or 96.34 U.S. cents.

A U.S. default would roil markets and economies around the world. At the same time, the fiscal standoff has seen the U.S. government partially closed since the beginning of the month.

Any economic fallout from the shutdown could also impact Canada, whose largest trading partner is the United States.

If the likelihood of a default starts to increase, some investors could push into short-term Canadian treasury bills, though money is more likely to go into bond markets with greater liquidity, such as Britain and Japan, said Smith.

The impact a default would have on the Canadian economic growth outlook could also limit flows into Canadian bonds, Smith said.

On Wednesday, government bond prices were mixed across the maturity curve. The two year bond was unchanged to yield 1.234 percent, while the benchmark 10-year bond fell 17 Canadian cents to yield 2.671 percent.

Canadian treasury bills and government bonds were outperforming their U.S. counterparts. The spread between what Canadian and U.S. three-month T-bills yield narrowed to 78 basis points from 82 basis points on Tuesday, as investors demanded less of a premium to lend to Canada.

(Editing by Theodore d'Afflisio)