Loonie Down! The Canadian dollar is down more than 15% in 2015

The Japanese yen was the top performing currency of the week, spurred on by safe-haven moves by the unwinding of carry trades ahead of next week’s FOMC decision and due to falling equity markets. The big loser last week was the CAD as it nearly shed 3%. It was the second biggest down week for the CAD this year – the other occurring after the surprise January rate cut by the Bank of Canada. The big fall in crude was last week’s culprit. The Canadian dollar is down more than 15% in 2015, and next year doesn’t look promising considering that Bank of Canada Governor Stephen Poloz has suggested that further drops in oil prices may encourage more monetary easing. Furthermore, last Tuesday the BOC unveiled the bank’s new “Framework for Conducting Monetary Policy at Low Interest Rates”, which included tools such as quantitative easing and negative interest rates.

US Federal Reserve Chair Janet Yellen

With interest rate futures pricing in an 80% chance that the Fed will raise interest rates at December 16th FOMC meeting and 96% of the economist polled by Bloomberg expecting a rate rise, let us assume for now that it happens. At this point, Fed inaction could trigger a market meltdown, revealing fears over the health of the U.S.and global economy and, after having talked up the
prospects of tighter monetary policy for months, severely damaging the Fed’s hard-won credibility. Judging by our conversations with clients this week, they also expect the Fed to raise rates and for the USD to rally on this news. However, the price action in the currency markets last week suggest that the market has already priced in this event and has now shifted its focus to what follows after the hike.

The current economic backdrop in the U.S. doesn’t exactly scream “rate hike.” Equity markets are facing an earnings recession due to price pressure on crude and USD appreciation. The Nov ISM manufacturing index fell below 50 to the lowest since 2009, dragged down by high dollar and weak global demand. The Nov ISM non-manufacturing survey fell to 55.9, its lowest level since May. Inflation reading and consumer spending are running at very lackluster levels. Even the most recent supposedly good jobs report, that showed 211,000 jobs created in November, included a huge jump in the number of people (319,000) taking part-time jobs because they couldn't find full-time work. You might be asking yourself, ‘Why is the Fed raising the rate now?’, which is a valid question. If the current interest rate was at, say 4%, would the Fed by hiking rates then? Probably not, but the Fed wants to move off the zero interest rates in order to give themselves some room to move in cutting rates in the future, if the economy or markets need it.

The good news is that because of the current economic back-drop, the pace of interest rate hikes will probably be the slowest in history. The Fed will go out of its way to paint this interest rate hike as the most dovish hike of our time.

China Begins G-20 Leadership with Ideas to Reduce US Dollar’s Role

This week, we continue our coverage of China and its yuan as it enters a critical year of influence and inclusion in the global markets. The following is an excerpt from an excellent essay written by Enda Curran of Bloomberg Business.

As China takes the reins of the Group of 20 for the coming year, the first indications are emerging of its agenda. Among the priorities: making the global system more resilient to shocks and, perhaps, less reliant on the U.S. dollar. China is setting up a working group led by South Korea and France to develop proposals, including on ways to strengthen the role of the International Monetary Fund’s reserve-currency unit, which is set to incorporate China’s yuan as a component next year.

China also wants a discussion around whether some commodities should be priced in the IMF’s reserve currency, known as Special Drawing Right or SDR, according to a European official involved in the G-20 talks. Notably absent from a senior role so far is the U.S., owner of what’s still the world’s dominant currency. China’s leadership has for years sought to strengthen the international use of the yuan, and encourage debate about lessening reliance on the dollar.

A surge in demand for dollars as a haven during the 2007-2009 global financial crisis first spurred China’s calls. As chair of the G-20 in 2010, South Korea attempted to lead an effort to widen the international financial safety net, urging the adoption of permanent currency swap lines. The U.S. nixed the idea, withthen-Federal Reserve Chairman Ben S. Bernanke saying officials shouldn’t provide a "permanent service" to financial markets.

Half a decade later, Chinese President Xi Jinping has the chance to put his imprint on a forum first set up during the Asian financial crisis of the late 1990s as a grouping of the largest emerging and developed markets to address systemic risks. "We have seen China grasping every multilateral occasion to enhance its image and leadership role, be it regionally or globally," said Yun Sun, a senior associate with the East Asia Program at the Stimson Center in Washington. "There is little reason for China not to fully exploit the G-20 chairmanship."

China has an ever bigger stake in global financial stability as it endeavors to reduce its own limits on cross-border capital flows, part of a broader plan to give markets a more prominent role in the Communist-run country. Among the challenges for the coming year will be weathering the Fed’s shift to monetary tightening, potentially sending emerging market currencies lower as money heads into higher-yielding dollars.

The G-20 under China’s presidency will also need to consider whether to let expire $250 billion worth of its reserve unit issued in 2009 to boost liquidity during the global financial crisis. China’s G-20 chairmanship began at the start of the month, a day after the IMF said the yuan met the requirements for joining the dollar, euro, yen and pound as one of the currencies backing the SDR, a sort of overdraft account for IMF members. China central bank Governor Zhou Xiaochuan in 2009 advocated expanding the use of the SDR unit in calling for a "super-sovereign reserve currency."
Nothing came of Zhou’s call six years ago, and changing the global financial architecture now remains difficult, analysts say. "We will need another global crisis, and one whose roots can be clearly identified in the shortcomings of the current non-system, for this to happen," said William White, an adviser to the Organization for Economic Cooperation and Development. The G-20’s agenda can also become dominated by pressing issues of the moment. "I suspect that geopolitical issues will trump economic ones," White said.

Whatever else, China’s leadership of the group offers Xi a vehicle to promote his country’s rising global role. The last time China hosted the G-20, in 2005, it was the world’s fifth-largest economy. It’s now No. 2, having surpassed the U.K., Germany and Japan. Its Asian rival will be chairing the Group of Seven developed nations next year. G-20 members are Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, South Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, the U.S., the U.K. and the EU.

"China can and should look to be ambitious, and aim for actions that demonstrate global leadership," said Tristram Sainsbury, a research fellow at the G-20 Studies Center at the Lowy Institute for International Policy in Sydney. "But China needs to be realistic of the limitations of the G-20 forum -- it is consensus based, and has several design flaws, such as a rotating presidency and a lack of focus stemming from an inability to drop items off the agenda."