Word Play

The two key events last week were the release of the Federal Open Market Committee (FOMC) Minutes from the October meeting and a speech by European Central Bank (ECB) President, Mario Draghi. Trading during the first two days of the week was rather lackluster. That changed on Wednesday as the USD climbed against all the major currencies, as traders bid up the USD on hopes that the 2pm release of the FOMC Minutes would cement the view that the Fed was finally ready to pull the trigger on an interest rate hike at its December meeting. After the release the USD sold off as the Minutes failed to deliver the market’s conclusion. Art Cashin, UBS Director of Floor Operations, beautifully put the minutes into perspective. He outlined the word play in the key paragraph:

During their discussion of economic conditions and monetary policy, participants focused on a number of issues associated with the timing and pace of policy normalization. Some participants thought that the conditions for beginning the policy normalization process had already been met. Most participants anticipated that based on their assessment of the current economic situation and their outlook for economic activity, the labor market, and inflation. These conditions could well be met by the time of the next meeting. Nonetheless, they emphasized that the actual decision would depend on the implications for the medium-term economic outlook of the data received over the upcoming intermeeting period. Some others, however, judged it unlikely that the information available by the December meeting would warrant raising the target range for the federal funds rate at that meeting.

If we analyze the words in the paragraph we can draw a proper conclusion. We see that “some” (a minority not a majority) of the Fed members think the conditions are “already” strong enough to call for a rate hike. We also see the “some” members don’t feel that they will have enough data by the December meeting for a rate hike. Finally, and most importantly, we see that “most” (a majority) believe that conditions “could” improve enough by the next meeting to allow for a hike. Thus, it still looks like the Fed is data-dependent. Talk about markets hanging on every word.

The AUD was the best performer last week, putting in its largest five-day advance in six weeks as it broke out of its downward slump dating back to early October. There was no change on the domestic side of the equation for the Aussie, so the breakout was due the Fed Minutes as explained above. The AUD has declined about 11.5% YTD, so it’s only logical that on a week where the USD corrects that the AUD bounced back the most on short covering flows. The AUD extended its gains on the Friday after head of economic analysis for the Reserve Bank of Australia, Alexandra Heath, stated that the Australian economy was withstanding the slump in trade following the end of the mining boom.

The Swiss franc was the worst performer on the week, and the reason it was down was due to ECB President, Mario Draghi. In a speech in Frankfurt on Friday, Draghi said that ECB policymakers would, “do what we must to raise inflation as quickly as possible”. This was reminiscent of his other famous declaration during the Eurozone’s debt crisis in 2012 when he stated that he would do, “whatever it takes” to save the single currency. He went on to reiterate that he and the ECB Governing Council are fully ready to act on December 3rd to rapidly deploy a range of monetary policy measures designed to lift the inflation rate within the single currency region from the level of 0.1% recorded in October. So again, it was a play on words that single handily moved the euro once again. Ironically, back in 2012 his word play was the catalyst to arrest a fall in the euro while Friday’s words were used to derail the euro. Thus, with the Paris attacks and Draghi’s comments, more monetary stimulus is a certainty next month.

And this brings us to the reason why the CHF was the worst performer last week – when the ECB moves in early December it will kick off another round of central bank stimulus by those countries that would see their currencies move up from incoming flows from the Eurozone. Those countries would be Sweden, Denmark, and Switzerland. Incidentally, those three countries currently employ negative rates to deter euro flows. If you recall, Switzerland broke its three year euro peg in January just before the ECB started its QE program. Thus, the pressure will be on the Swiss National Bank to deter more euro flows due to the ECB’s next move.

With holidays in Japan and the U.S. in the week ahead, liquidity in the markets will be the less than ideal for trading activity. Having said that this, Fed policy speculation will likely continue to preoccupy traders. Preliminary PMIs in Europe, revised Q3 U.S. GDP figures, as well as improvements in measures of consumer confidence and durable goods orders are expected in the week ahead. All of this will likely offer additional fodder for December rate hike bets, amplifying the projected policy divergence between the Fed and its G10 counterparts.

Australia reports strong jobs numbers!

After finishing in second place last week the AUD was able to supplant the USD, as it failed to maintain its lead in the week after the exceptionally strong U.S. jobs report which had helped fan expectations of a December Fed rate hike. Similar to last week, it was the jobs report that helped power up the performance of the domestic currency. Australia recorded the largest payroll increase since early 2012 as the economy added 59K jobs in October, beating expectations of 15K and a -1K decline in September. The unemployment rate dropped to 5.9% from 6.2% a month ago, marking the lowest level since May 2014, while the participation rate picked up to 65% from 64.9% in the prior month. The internals were also stellar as both full-time and part-time jobs rose last month with the former gaining 40K (following September upwardly revised 10K decline) and the latter adding 19K (compared with September's 10K increase). Just to put these numbers into perspective, the 59K October jobs gain would equate to over 800K new jobs in the U.S.; and just last week the market was cheering about the 271K increase.

Surprisingly, the GBP was able to match the AUD’s gain after last week’s disastrous Super Thursday performance which was outlined in detail in last week’s Dispatch. The labor market also played a role in relation to the domestic currency 1.21% gain as the unemployment rate fell unexpectedly to a fresh seven-year low of 5.3%. Meanwhile, employment rose by 177,000 over the quarter, meaning there are now 31.2m people in work, according to the Office for National Statistics. Comments made by Bank of England Governor Mark Carney encouraged speculation that the central bank could move on interest rates sooner than previously suggested. Carney told Bloomberg he believes the U.K. economy, which is forecast to grow at 2.7% this year, may soon have the right conditions for a rate rise.

The odd person out last week belonged to the CAD with a weekly decline of 0.15%. The main culprit was the 8% drop in the price of crude as prices fell toward the $40 handle. The decline this week came from fresh signs of increasing supply due to abundant supplies and slackening demand, especially in China. The IEA said global oil-demand growth will slow to 1.2 million barrels a day in 2016, after surging to 1.8 million barrels a day this year, a five-year high. Having said this, Friday’s tragic terrorist attack on Paris could further slow the global economy and demand for oil. Thus, weakening oil prices may exert even more downside pressure on the CAD to start the week on top of key reports due this week on inflation and retail sales.

Last Thursday, no less than six Federal Reserve policy members spoke. We won’t bore you with the details of each speech – the common take away was that the Fed is ready to raise interest rate if the data supports the move.

IMF Will Decide the Near-Term Future of the Yuan

Most market analysts have little doubt the that Chinese yuan will one day be part of the International Monetary Fund’s special drawing rights (SDR) at some point in the future, but very few believe that it will happen by the end of this month. On November 30th the IMF Managing Director Christin Lagarde will make a decision about the CNY becoming part of the SDR, which is a multilateral institution basket of currencies that include the USD, EUR, GBP and JPY. However, if the IMF surprises us all, the inclusion of the CNY into the SDR could be the spark that fires the yuan rocket in the years ahead as a global reserve currency, likely replacing the Japanese yen and Great Britain pound in the currency hungry emerging market central banks.
It was only a few months ago that several media outlet reports suggested that people inside the IMF were saying that the yuan was not yet equipped for prime time. However, more recently Ms. Lagarde stated, “The IMF staff assessed that the RMB [CNY] meets the requirements to be a ‘freely usable’ currency and…proposes that the Executive Board determine the RMB to be included in the SDR basket as a fifth currency, along with the British pound, euro, Japanese yen, and the U.S. dollar.” She added that the staff also found that Chinese authorities have addressed “all remaining operational issues identified in an initial staff analysis submitted to the Executive Board in July. I support the staff’s findings.” This is big news.

The decision to include the CNY into the SDR will not rest entirely on Ms. Lagarde. The market at large will have a say as well. Meanwhile, China is busy building up its local bond market with the hope that it will be seen by Asian institutional investors, emerging market central banks and big sovereign wealth funds as a safe haven alternative to U.S. Treasury bonds at some point in the near future.

In August, the Peoples Bank of China (PBoC) allowed the CNY to trade within a wider band, which resulted in a weaker yuan. The result was furious push-back from Western economies because they felt that it was a protectionist measure to manipulate its currency in order to save its export
manufacturers at a time when the economy is growing slower than it has in years. However, it’s important to keep in mind that the yuan at the time was the strongest in the region – stronger than the likes of South Korea, Taiwan and the Singapore Dollar. Moreover, the trading band actually gave the market more say to sell the CNY short and weaken it against the USD and EUR. In its history, this is the closest China has come to free-float the CNY. China still has a long road ahead, but its goal to become a reserve currency has gain momentum. However, the PBoC’s strict control on the flow of the yuan will continue to impede its progress and restrict it from becoming a basket currency, as all other currencies in the IMF’s SDR are determined by the market.

5 Things to Know about Canada's Economy

5 Things to Know about Canada’s Economy
From the World Economic Forum

The sweeping election victory of Justin Trudeau’s Liberal Party has thrust Canada’s economic woes into the global spotlight.

The commodity-based economy is technically in a recession, owing in part to this year’s fall in oil prices. But the country is also suffering from deeper structural problems. Addressing these challenges and building an economy for the 21st century are among the key challenges facing Canada’s new prime minister.

Reliance on crude oil
Canada’s economy, ranked 11th in the world by GDP, has focused on resource extraction in recent years. While crude oil, Canada’s big commodity export, helped the country get through the global financial crisis relatively unscathed, the low oil price is now putting the economy under severe strain. This year, Canada’s economic performance has been the worst among a small group of developed economies that depend heavily on resources, such as Norway and Australia. Between June 2014 and July 2015, revenue from Canadian energy exports decreased 34.6%, forcing producers to cut back on jobs and investments.


Structural problems

The drop in global energy prices is not the only reason for Canada’s sluggish economy. There is much hand-wringing over Canada’s lack of innovative, globally competitive companies at a time when its traditional manufacturing industries are being eroded. Canada trails other developed economies in areas including corporate research and development, information technology investments, patents and productivity.

Debt and overvalued housing
There are concerns that ultra-low interest rates, currently at 0.5%, have been driving unsustainable housing booms, particularly in Toronto and Vancouver. Consumer debt is at a record 165% of disposable income, with most of the borrowing going into buying houses. Bank of Canada Governor Stephen Poloz said that increasing levels of household debt represent “a key vulnerability for the financial system”.



Budget deficits and spending
Canada’s recession made stimulating economic growth a key topic in the election. Conservative leader Stephen Harper, who stepped down after almost a decade in power, pledged to run a balanced budget. In contrast, Trudeau said he would tackle the economic downturn by running budget deficits of $25 billion over the next three years to fund infrastructure. The incoming prime minister has also pledged to cut income taxes for middle-class Canadians while increasing them for the wealthy.

The Keystone oil pipeline
Mr. Trudeau plans to address environmental concerns over proposals for the controversial Keystone oil pipeline, which has put relations between the US and Canada under strain. Mr. Harper had hoped the pipeline, which would carry crude from Alberta to Texas, would create jobs, but President Obama rejected the plan late last week. Essentially, the President was doing Hillary Clinton a favor in her run for the White House, but inadvertently did Mr. Trudeau a favor as well.









The USD was the undisputed winner on the week, easily outpacing its nearest competitor by a margin of 1.31%. The USD surged higher on the back of a very strong labor report that smashed expectations. The U.S. economy created 271K jobs for the month of October, which was the strongest monthly increase in payrolls this year. The unemployment rate also dropped to 5%, the lowest level since 2008. And for good measure, average hourly earnings rose 0.4%, which was the largest increase since July 2009. These strong numbers allowed the market to recalibrate the odds of December interest rate hike by the Fed from 56% to 72%. Meanwhile, the worst performing currency was the NZD after the latest Global Dairy Trade auction revealed that prices fell by 7.4%, the biggest drop in 3 months.

The Bank of England’s second Super Thursday triggered a selloff of 2.44% in sterling last week, its worst performance in eight months. Super Thursday occurs when the BOE releases its latest policy decision, the minutes of their deliberations and their quarterly forecasts for growth and inflation. The BOE left rates unchanged at 0.5% as expected with an 8-1 vote. However, it was the bank’s Quarterly Inflation Report that really tarnished sterling. The bank slashed inflation targets and GDP growth for 2016 to 1% and 2.5% respectively due to its concerns about global growth and the impact of commodity prices on inflation. Adding to the dovish tone, the central bank said that asset purchases (QE) would only be unwound when the key rate reaches 2%. Even though BoE Governor Mark Carney said in the press conference that it is “reasonably prudent to think BoE rates will rise in 2016”, the market pushed out the timing of its first interest rate hike due to the dovish Quarterly report. Thus, the BOE is still expected to be the second major central bank to hike rates after the Federal Reserve, however, the gap between the Fed's move and the BOE's move has widened causing the GBP to selloff.

Last week’s price action saw the pound hold support above the 1.50 level. If supports breaks that would open up a decline to the next support level just about the 1.48 level. Furthermore, the weekly close of the pound has bearish implications as it recorded an outside down week. Unfortunately, the pound could face more pressure this coming week as Premier David Cameron writes a letter to the EU setting out the UK’s conditions to remain in the EU, or said in a negative way, Britain’s EU exit warning.

Backchannel chatter

The CAD, which had been down every day since the federal election, managed to close out the week on firmer ground, led by a rebound in oil prices. U.S. government data revealed a weekly increase in crude supplies that was smaller than forecast while distillate stockpiles fell more than expected. However, caution is warranted for the longer term once sanctions are lifted on Iran, which holds 13% of the world’s oil reserves. The USD took a breather last week after sprinting to the top of the leader board at the previous weeks’ close. More stimuli by China and a promise of more stimuli by the ECB proved to be the enablers. Last week’s out performer was the GBP, even though it lacked a clear catalyst. The pound essentially reversed its decline following last week’s FOMC policy meeting and may trade higher before squaring up ahead of the Bank of England interest rate decision on November 3rd. The Aussie was the biggest under performer of the week, as softer than expected Q2 inflation data spurred expectations of an interest rate cut at this week’s Reserve Bank of Australia policy meeting November 3rd.

The FOMC decision was the main event of last week. With everyone and their grandmother expecting a dovish statement the market was caught leaning the wrong way when the decision was announced. All it took were four little words buried in the opening sentence of the third paragraph of the FOMC statement to cause a violent surge in the USD – “at its next meeting” US policymakers may consider a rate hike. The Fed also decided to remove the paragraph worrying about global headwinds, which added to the more hawkish tone of the statement. The reason for the retracement was due to backchannel chatter and weak U.S. economic data. According to Matthew Saltmarsh of MNI (Market News International), the U.S. asked the ECB to refrain from talking down the euro, which can be found here. This would indicate that the strength in the USD is indeed a concern to U.S. policymakers and it may very well cause them to delay an interest rate hike. The other backchannel chatter revolved around the aforementioned sentence. According to Art Cashin, Director of Floor Operations at UBS, that sentence has the markings of Vice Chair Stanley Fischer. Since his appointment to the Fed, Fischer has repeatedly and consistently pushed to have the FOMC drive the idea that a liftoff in 2015 was not only possible but maybe even likely. Thus, the chatter was that the sentence was only seen as an appeasement to Fischer’s posture rather than a clear intent to raise rates. The weak and lackluster U.S. economic data continues to cloud interest rate policy. Last week it was a steep fall in September U.S. new home sales, a soft durable goods orders report, and disappointing U.S. Q3 GDP of 1.5% (which is likely to be revised lower). With Q1 GDP coming in at 0.6% and 3.9% in Q2, that puts the U.S. economy at about 2%. This is hardly an economy that policymakers around the world would classify has having “escape velocity” worthy of an interest rate hike. All in all, the economic data is not good and the real economy shows signs of slipping into recession. Heck, the U.S. may already be in a recession if we cut through the spin of some of the data but it could take more than a year for the National Bureau of Economic Research to officially call one.