IB FX Brief
Canadian dollar in purgatory
Friday March 19, 2010
A jump in the core inflation rate in Canada has dealers left wondering how much longer the Bank of Canada will be able to maintain its conditional commitment to a near-zero interest rate policy. February data rose above the 2% target and leaves the central bank floundering against a January prediction that not only would the first quarter core rate average 1.6%, but also that inflation wouldn’t disturb the central rate until the third quarter. Growing expectations surrounding the economy and the relative monetary response compared to United States has had investors plundering the so-called loonie lately driving its value back towards parity. The response today was another surge in the local dollar.
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Canadian dollar –The Canadian dollar has acted like a pressure cooker lately with an increasing number of factors turning up the heat. Its primary appeal stems from the fact that as a resource-rich nation the fundamental demand for base, semi and precious metals works its way through the currency. Global recovery also reflates demand for crude oil and natural gas. In recognizing both Canada’s strong growth and global recovery, central banks and overseas governments have stepped up the allocation of Canada’s dollar within reserves. The fact that Canadian fiscal policy is likely to return a balanced fiscal stance within five years is a huge positive when the rest of the world’s advanced nations are suffering under the stresses and strains of ballooning deficits for as long as the eye can see.
While the core CPI data for January had risen to 2% it was widely expected to ease back to 1.7% in February. However, this morning’s data showed a further acceleration to an annualized pace of 2.1%. The news catapulted the loonie from a low of 98.15 U.S. cents ahead of the data to 99.05 cents as speculation swirled that the Bank of Canada might yet have to deliver a surprise return to normalization in light of positive economic data. In January the Bank of Canada predicted a first quarter average core CPI reading of 1.6%. To achieve this would require a 0.7% reading for March, which would be practically impossible save for downward revisions to previous data in a month’s time.
The pressure is now on the Bank of Canada to delicately explain that fantastic economic conditions have materially changed the inflationary trajectory and that to ignore it would risk having to act more than would be required if it could shake off its commitment through June. It could always shake off any interest rate increase on the unexpectedly successful political and fiscal measures speedily enacted after the global crisis.
The final thought to ponder is the likelihood of implicit monetary tightening in the event they try to string the party out through June. There is likely to be intense speculation at each meeting to that point with speculators betting via the currency that the Bank will be forced to act. Any disappointment will be hard to contain because the later the central bank leaves tightening, the more they will have to do, which would only enhance the appeal of a currency in purgatory. And by the way, that’s not near Calgary.
Euro – The euro is one again suffering at the hands of European discord to end the week. With the Greek Prime Minister threatening to take his woes to the IMF for financial aid, divisions within the EU are becoming blatant. French President Sarkozy and ECB President Trichet have already said that the path to the IMF should be ruled out on account that it shows the EU can’t solve its domestic challenges. Meanwhile German Chancellor Merkel predicts that this path maybe the only viable one for the government of Greece. From the perspective of the investor, events continue to be frustratingly opaque. Repeated meetings result in no clear statement other than a commitment that now appears far less solid than before.
Thus Greek PM Papandreou is holding a gun to whichever head he can by threatening to scoot off to the IMF if next week’s (24-25th March) meeting of ministers fails to deliver an explicit financial aid package for his nation. The problem facing the euro right now is that Mr. Papandreou could very well be pointing the gun in his own direction in the event that the EU fails. That could be very tricky for the EU and thus the euro’s weakness continues in to the weekend where the unit has once again slumped towards $1.3550 – its lowest since early last week.
U.S. Dollar – Although it did no material damage to equity prices on Thursday, the rumor doing the rounds that the Fed was ready to make a second adjustment to its symbolic discount rate has traders on edge at present. We do not know the source of the story but can only say that the Fed is unlikely to pause in lifting that rate gradually until the spread between it and the fed funds rate has widened satisfactorily. Typically that could be a 1% spread, in which case there are two further moves whose timing is pure speculation, but before the summer would make sense and probably cause no harm. And while this isn’t a factor for driving the dollar higher since it genuinely does not signal and change to official policy settings, it does serve to highlight the deviant paths for monetary settings between domestic and Japanese policy.
British pound – The pound fell following words from a British policymaker that may be taken somewhat out of context. The headline story is the CNBC interview with the MPC member Andrew Sentance, who highlighted the potential facing Britain for a double-dip recession. On the face of it this is pretty bearish and created repentant bulls out of those eager to buy the pound earlier in the week after a positive jobs report.
However, Mr. Sentance did warn that this is not the Bank of England’s central view and that the risk to a secondary downturn for the economy comes from an external shock. This part of the story seems to have been overlooked today. One understands the weak domestic situation facing the British economy, but equally we know that fog is lifting. To fear further would be foolhardy on the simple basis that an external shock might happen. It makes more sense in light of recent data to maintain some optimism on the pound rather than to wear a hair-shirt and go about beating one’s chest in the worry that external factors become derailed. The pound eased against the dollar to $1.5146 and lost some ground to the euro at 89.44 pence.
Japanese yen – The yen is falling against the dollar at ¥90.59 on Friday as investors keep one eye on rallying Asian stock markets and try to consider the role of the yen as a risk aversion vehicle. In a world of growing confidence and one where central bankers are discussing the need to unhitch their wagons from emergency monetary levels, one just cannot envisage a time ahead when the same can be said of the Japanese economy.
Aussie dollar –TheAussie dollar is finding the going a little harder in the environment where investors are jittery over potential Chinese action to stem growth. A headline-grabber earlier this week concerned the ban on bank lending to speculators in the land and real estate markets. The story is open to interpretation but the potential for further official Chinese measures that would stall growth is enough for now to curb enthusiasm for the Aussie currency, which today eased to 91.93 U.S. cents.
Andrew Wilkinson
Senior Market Analyst ibanalyst@interactivebrokers.com
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