FED UP

The top spot this past week belonged to GBP which managed to rally over 1% on the week on a great retail sales report and favourable Brexit polls. Retail sales in the UK rose by 1.3% on the month in April, despite the cold weather and well above economists' average forecast of 0.5% growth. The GBP also received a boost by some polls indicating a shift toward the Remain camp.

The CAD will be on the radar this week as it has has fallen against its US counterpart for the past three weeks, matching its longest streak of the year. It is now at its worst level in a month and could move even lower as the Bank of Canada is expected to strike a more dovish tone in its policy meeting tomorrow due to the still-raging wildfire in Alberta that has disrupted oil production.

Until last week’s release of the minutes, markets were discounting extremely low odds on a US Federal Reserve interest rate increase in 2016, let alone a summer rate hike. The reason for this was due to the dovish tone of Fed Chair Janet Yellen’s speech shortly after the April FOMC meeting. In Fed speak; we can say that her dovish stance was transitory because last Wednesday’s release of the minutes from the April meeting suggested that policy makers thought that an interest rate increase would be appropriate in June if the economy continued to improve. Excuse us for being skeptical, but where have we heard this before. In plain English, I think the minutes were trying to tell us that the Fed’s decision will be data dependent – really, when hasn’t it been.

On the following day, NY Fed President William Dudley helped to cement the feeling that a summer rate hike was indeed in the cards. He said, “If I am convinced that my own forecast is sort of on track — then I think a tightening in the summer, the June, July timeframe is a reasonable expectation.” This notion was also echoed by Boston Fed President Eric Rosengren when he told the Financial Times that he was getting ready to back tighter monetary policy. Rosengren’s stance is interesting as he was one of the Fed doves last year.

After a number of false starts by the Fed we are hesitant to buy into the rate hike scenario. First of all, the June FOMC meeting is on June 14-15 – one week before the critical Brexit referendum vote on June 23. We doubt very highly that the Fed would raise interest rates before such a critical vote which has the potential to inflict significant market disruption if the UK were to vote to leave the EU. Secondly, the July FOMC meeting does not have a press conference afterward. It would seem very unlikely for the Fed to make a policy move without the benefit of a press conference after the meeting – especially since they like to paint their rate hikes with a dovish tint in order to minimize the damage to equity markets. And speaking of equity markets, everyone knows that deep down that’s what the Fed really cares about – with this in mind we present to you the working flow chart of the data dependent Fed, just kidding but not really sure.

Clarity

The commodity currencies – CAD, NZD and AUD – were the worst performers on the week. The CAD was hit by a combination of soft commodity prices, a disastrous trade report – the worst deficit on record - and an overdue correction in its recent rally.The RBA cut rates earlier this week and, in their most recent minutes, indicated a dovish view on the outlook for Australian inflation, implying further rate cuts were possible.  GBP was relatively quiet, the only item of note being the Leave side taking a small lead in the Brexit referendum slated for next month. The two sides – Remain and Leave – have swapped places either side of 50% for some time now, so the news was greeted with some indifference. Lastly, given the lack of any negative news out of Europe – a welcome change, no doubt, for the region’s politicians – the EUR traded largely unchanged on the week.

It appears that US investors now have a measure of clarity that had been lacking for far too long. Firstly, with the rather disappointing US employment stats released last Friday, it is now clear that the US economy has stalled for the present. What will recharge the increasingly moribund economy isn't obvious, given that just about everything that has been tried has failed. Fed funds futures are now pricing in just a 4% chance of a rate hike in June and only 44% in December. (This latter percentage will likely drop further) So no rate hike in June and, as we have mentioned before, the odds of a Fed hike after the June meeting, during the onset of the federal election season, were always slim at best. Now it's essentially zero, and Mr. Market can see with unexpected clarity that the US economy is in serious trouble. The employment numbers are a lagging indicator and they have finally caught up with the leading macro indicators.

Secondly, with the recent triumph of Donald Trump over the vast Republican field, a large degree of clarity has emerged in the presidential race. Despite Bernie Sander's quixotic bid for the Democrat nomination, the nomination of Hillary Clinton has never been in serious doubt, notwithstanding her numerous issues. Now investors can focus on the two candidates and begin assessing their worthiness for the job of president. There are fundamental differences between the two parties and, beginning now, market players can start placing their bets.

Finally, given the weakness in the US, it appears that global interest rate levels will remain low for quite some time into the future - yet another instance of clarity for investors.

BOJ Inaction

The surpise of the week was the lack of new policy moves by the Bank of Japan. The market’s reaction to the BOJ’s inaction was swift as the yen soared by over 2% on the day and more than 5% on the week. The BOJ did do something – it cut its economic forecasts, predicting growth of 1.2% instead of 1.5% for the fiscal year to March 2017. It also cut its inflation forecast for the fourth time in around a year, from 0.8% to 0.5%. A case can be made that the BOJ refrained from making any policy change because it wanted to see the results of its newly enacted policy of negative interest rates working through the economy. Or that the BOJ wanted to pressure the government for a fiscal policy solution rather than a monetary policy fix, consistent with G20 concerns about the over-dependence on monetary policy.

There may be another, more political, reason for the BOJ’s surprise inaction – they didn’t have permission to do so. Late Friday, the US Treasury put out a new “monitoring list” – it placed China, Japan, Germany, South Korea, and Taiwan on a new currency watch list, saying that their foreign exchange practices bear close monitoring to gauge if they provide an unfair trade advantage over America. The US has not named a single country as a currency manipulator since it did so to China in 1994 – so it would appear that the US is very serious about this now. Let’s not mince words here - this is a direct threat to the rest of the world that it not engage in any monetary policy (QE, NIRP, or ZIRP) that is tantamount to currency devaluation, without express written consent of the US government.

It would appear that the US government has decided it has had enough of the currency wars and it will no longer tolerate a high dollar as a headwind to US economic advancement. This may have signaled the end of the friendly currency wars, but we suspect that it will invite a response by China, Russia, and the rest of the emerging nations to seek an end to the USD reserve currency hegemony. You will hear more about the IMF’s SDR and gold in the not too distant future.

In last week’s blog we stated that if the Fed was able to craft a policy statement that adopted a more balanced outlook for the economy and inflation then it could further fuel the rally in the dollar index. Well, the Fed disappointed and the dollar took it on the chin. The index took out the recent swing bottom at 93.62 and the August 24, 2015 main bottom at 93.50 and the momentum indicators have rolled over. Another bearish sign - a death cross is about to form as the 100-day moving average is set to drop below the 200-day moving average.

The US didn’t help itself either – Q1 GDP slowed to 0.5%, the weakest pace in two years and lower than economists' expectation for 0.7%. Also, the Fed's preferred inflation barometer, the PCE index, rose just 0.8% in the 12 months ended in March, remaining below the Fed's 2% target. The combination of a stagnating economy

Prior to the FOMC meeting the CME Fed futures tool was pricing a 23% chance of a June rate hike. As of Friday, the probability of a June hike has dropped to 11%. The exclusion of the balance of risks statement by the Fed for the 3rd consecutive FOMC statement confirms the market’s view that the Fed will not be hiking rates at its next meeting in June. Furthermore, June is fraught with international considerations which could keep the Fed from hiking – UK referendum, the Spanish election, the possible impeachment of the President of Brazil, and the rekindling of tensions between the EU and Greece. So, given the Fed wishes to appear politically impartial, if there is no rate hike in June then it is difficult to envision the Fed hiking rates as the US moves closer to electing a new President in the fall. Thus, the market is skeptical that it will raise rates at all in 2016 – the probability of a December hike has dropped to 60% as of Friday from 71% just prior to the FOMC meeting.

Countermeasures

The CAD and the GBP were the top performers last week while the yen lagged. The CAD was right behind the GBP as oil and the rest of the commodity complex continued to perform well. Canadian domestic data also helped as March retail sales increased and inflation continued to firm. It also didn’t hurt that Bank of Canada Governor, Stephen Polz, did not express dismay about the recent strength in the domestic currency unlike other global central bankers.

The GBP proved to be resilient in the face of poor data as it recouped its losses from the previous couple of weeks. Economic data from the UK continues to be sluggish as evidenced by last week’s disappointing retail sales and employment data. In fact, this upcoming week’s release of GDP growth will probably show that growth has slowed down due the weight of uncertainty around Brexit. However, the latest polls show that the “stay” in the EU vote is gaining traction, so much so that the probability of Britain voting to leave the European Union dropped to 20%.

Yen strength over the past several weeks finally relented. Of course, it didn’t hurt that Japanese officials floated a trial balloon about negative interest rate loans. That’s right, this isn’t a typo - apparently the Bank of Japan is considering paying banks to make loans. The ECB also mentioned this as a possibility at its March policy meeting. The BOJ’s Stimulating Bank Lending Facility, which now offers loans at zero percent interest, would be the most likely vehicle for this option. The BOJ board next meets to set policy April 27-28 and it is desperate to deploy countermeasures to counter an appreciation in the yen, especially after being denied the use of currency intervention by the G7 and G20. The BOJ may decline to make a move at this meeting if the Fed does its work for it by being more hawkish at its policy meeting on April 27.

This week the US Federal Reserve will probably seek to convince all of us that it will raise interest rates this year. It will not raise rates at this meeting but it will try to convey that a second rate hike may come at its June meeting. This train of thought seems to dovetail nicely with the performance of the US dollar index. The index has carved out a bottom over the last couple of weeks and the momentum indicators are all aligned for more gains. So if the Fed is able to craft a policy statement that adopts a more balanced outlook for the economy and inflation then this could further fuel the rally in the dollar index.

In last week’s blog we mentioned that the commodity complex has been on a tear. It has now advanced for nine weeks since putting in a double bottom in early February. Under closer inspection, the commodity futures price index, the CRB, has broken out and has reached its highest level in five months. The momentum indicators are giving the all clear sign for additional gains. This tells us that central bankers are finally going to get what they have all desperately tried to achieve – inflation. That’s right folks; the inflation shock will probably be the story for the latter part of 2016. If inflation becomes entrenched, then the central bankers will be desperate to try to tame it – I guess this is what they mean when they say “be careful what you wish for”.

Doves vs. Hawks

The commodity currencies of Canada, Australia and New Zealand led the way higher in FX last week underpinned by firmer commodity prices and an improving China. The commodity futures price index, the CRB, has advanced for 8 weeks since putting in a double bottom in early February. China’s industrial output and retail sales surged in March urging greater confidence that China’s economy has stabilized and will avoid a hard landing. Of course, the better the Chinese economy performs the better the continued advance for commodity prices.

There were no less than eight Federal Reserve Presidents speaking last week. Some were doves, some were hawks, some were FOMC voting members, and some were not. One wanted a rate hike in April; others ruled out an April hike but favoured a June hike; and one (Lacker) was busy making a case for four rates hikes in 2016 – I kid you not. I don’t know about you, but methinks that continued pontification by US Fed members is starting to fall on deaf ears. I think the market is sensing this as well – US Fed fund futures is pricing in 2% chance of a rate hike at the April FOMC meeting, 13% for June, 28% for July, 36% for September, 40% for November, and 52% for December, 55% in February 2017. In other words, the market is pricing in no rate hike until 2017.

So with possible interest rate hikes being pushed out further in time, the USD continued to be shunned. U.S. economic reports didn’t help the dollar’s cause either. A horrible retail sales report and a disappointing inflation report undermined the US Fed’s interest rate hike expectations.

At the time of this writing, we learn that the world’s major oil producers failed to reach an agreement to freeze oil production at this weekend’s OPEC and non-OPEC meeting in Doha. No one should be surprised by this as, over a month ago, the Saudis stated that there would be no agreement without Iran’s participation. There was no way that Iran would agree to freeze production now that they have been allowed to sell oil again on the world market after agreeing to forgo their nuclear ambitions; and the Saudis knew this. The price of oil and the CAD have steadily gone up over the past two months on hopes of a deal.

我々は問題を抱えています - translates into: Tokyo we have a problem

The dominant theme in the currency market last week was the strong yen. What’s more, the upward movement in the yen flies in the face of the Bank of Japan’s NIRP (negative interest rate policy). When a central bank adopts NIRP, one of the effects should be a sharply weaker currency not a decisively stronger one.

This is a problem for Japan. A weak yen has been the key plank in “Abenomics” – Prime Minister Shinzo Abe’s turnaround plan for the Japanese economy. Japan has been plagued with deflation for over 30 years and a weaker yen is seen as the best hope. A weakening currency makes a nation's exports cheaper in other countries, and the theory is that expanding exports will boost the overall economy-- especially if that economy is stagnating or in recession.

This surge higher in the yen is leading to speculation about whether Japanese policymakers will intervene in the market. Intervention speculation is rooted in historical precedence because in previous similar situations the BOJ would aggressively intervene in the market by selling yen to weaken the currency.

However, it is unlikely that Japanese officials will directly intervene in the currency markets. They will most likely stick to verbal intervention with statements like “we are closely monitoring the currency”. The reason for this is twofold. Firstly, currency intervention is not very effective unless it is coordinated with other central banks. Secondly, intervention is frowned upon due to the consistent message from G7 and G20 meetings that countries should not seek a competitive advantage in the currency market. This is further complicated by the fact that Japan is hosting the next G-7 summit in May.

Yen strength is a real blow since it undermines the BOJ’s efforts to fight deflation. It also calls into question the credibility of not just the BOJ but that of all central bank in the market’s eyes. For instance, the euro had a simillar reaction to the last round of aggressive ECB policy action – it went up in the face of NIRP. The question being raised by the market is – what’s the point of continuing monetary polices of ZIRP, NIRP, and QE if a weaker currency is not achieved?

This type of talk is considered blasphemy to a central banker. We can be sure that the BOJ will promote an even more radical “whatever it takes” option to reflate the Japanese economy as soon as the next G7 meeting is out of the way – we can hardly wait.

Yellen Too Loud

The first trading day of the week was very lackluster with little to move the currency markets either way due to the Easter holiday break. This only helped to raise the anxiety level of traders as they waited for Tuesday’s speech at the Economic Club of New York by Fed Chair Janet Yellen. The question on everyone’s mind was did she mean to sound as dovish as she did in her post-FOMC press conference in mid-March, especially since various Fed presidents had taken a more hawkish tone since then. The answer is yes, she absolutely meant to sound dovish.

The third paragraph of her speech is very telling, it reads as follows: “In my remarks today, I will explain why the Committee anticipates that only gradual increases in the federal funds rate are likely to be warranted in coming years, emphasizing that this guidance should be understood as a forecast for the trajectory of policy rates that the Committee anticipates will prove to be appropriate to achieve its objectives, conditional on the outlook for real economic activity and inflation. Importantly, this forecast is not a plan set in stone that will be carried out regardless of economic developments. Instead, monetary policy will, as always, respond to the economy's twists and turns so as to promote, as best as we can in an uncertain economic environment, the employment and inflation goals assigned to us by the Congress." In other words, the Fed should proceed with caution and with a gradual approach in adjusting policy.

Ok, so Yellen stressed a “gradual approach” to Fed policy and, just in case the economy goes sideways or worse, the Fed is prepared to employ additional "money" printing (QE): "Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy--specifically, forward guidance about the future path of the federal funds rate and increases in the size or duration of our holdings of long-term securities. While these tools may entail some risks and costs that do not apply to the federal funds rate, we used them effectively to strengthen the recovery from the Great Recession, and we would do so again if needed." Really, we are back to this again. How successful was QE anyway? Not very, considering QE1 was followed by QE2, Operation Twist, and QE3.

Here is another unsettling part of the speech: "The FOMC left the target range for the federal funds rate unchanged in January and March, in large part reflecting the changes in baseline conditions that I noted earlier. In particular, developments abroad imply that meeting our objectives for employment and inflation will likely require a somewhat lower path for the federal funds rate than was anticipated in December. Given the risks to the outlook, I consider it appropriate for the Committee to proceed cautiously in adjusting policy. This caution is especially warranted because, with the federal funds rate so low, the FOMC's ability to use conventional monetary policy to respond to economic disturbances is asymmetric." So what you’re telling us is that the Fed’s “data dependency” will now include data like Japanese inflation, European GDP, and Chinese PMI – you get the picture.

It appears that Janet Yellen is not only dovish but she is a lot more dovish than anyone previously thought. To illustrate this point, the ninth footnote in the text of her speech stated “uncertainty and greater downside risk” when the Fed’s policy rate is so close to zero “call for greater gradualism.”

At the time of this writing, fed funds futures traders have revised down the implied probability of a June rate hike to just 26%, and “only” a 66% chance of another rate hike at all this year.

In the currency trade, it’s no surprise the the USD took the brunt of Yellen’s dovishness as it lost ground to all the major currencies. During the past week, multi-month highs for the AUD, NZD, and CAD were recorded. The big question is will the gains in commodity currencies last – investors are seeing the spike highs and the natural inclination is to think of exhaustion followed by reversals.

In other parts around the world the yen is the best performing currency in Q1, which is surprising since the Bank of Japan decided to up the ante with the introduction of negative interest rates. The GBP was in last place which is not surprising as the currency is being weighed down by the uncertainty of Brexit. To underscore this point, the global manufacturing PMIs were released on Friday and the only one that missed its mark was from the UK where the PMI reading printed at 51 versus 51.2 forecast. By the way, the PMI for China surprised to the upside with manufacturing activity expanding for the first time in 8 months – does this mean Yellen will raise rates – sorry we’re confused.

CAD Casualty

The CAD was the main casualty of the USD’s reversal, falling 1.95% on the week, which ended a nine week rally. The possible culprits for the drop in the loonie were the slump in the price of oil and/or the release of the Canadian Federal Budget.

The world’s eyes were on Canada last week as it became the first major industrialized country to opt for fiscal stimulus rather than rely solely on monetary easing. The Organization for Economic Co-operation and Development and the International Monetary Fund has stressed the need for governments to turn to fiscal policies instead of monetary central bank policies; and the Canadian government delivered by promising to spend more on infrastructure to boost growth. The Canadian Finance Department estimates that the stimulus spending will drive 0.5% of GDP growth. The government is putting the bulk of its effort on the middle class and expecting a positive spillover to the rest of the economy. The bad news is that federal finances will go from a near-balanced position of the past two years to big budget deficits of almost $30 billion (or 1.5% of GDP) for each of the next two fiscal years. Canada’s pristine balance sheet will be affected in the short term but with the current global backdrop this will be acceptable. The key for the currency will be for the medium term – will the government be able to reverse the deficits down the road? We will come back to this point in four years’ time.

With the cumulative burden of big deficits down the road, the CAD was weighed down more by the combination of a firmer USD and the lower price of crude. The price of oil approached the 200-day moving average around the $42 level last week and backed off after U.S. crude inventories jumped more than expected and gasoline stockpiles fell. The Energy Information Administration reported U.S. crude stocks rose by 9.4 million barrels in the previous week to a record total of 532.5 million barrels. Offsetting the build was a 4.6 million barrel decline in gasoline inventories. The EIA also said weekly production ticked down by about 30,000 barrels per day. This spells trouble for oil and the CAD as inventories are at all-time highs nearing full capacity as we approach the spring maintenance season for refiners.

The USD/CAD rate has moved up through the overhead downward sloping trend line drawn off the mid January high. The technical indicators are also aligned with the up move in the rate with the RSI rising and with the crossover in the MACD. A move to the 200-day moving average would be constructive. Also, if the price of oil were to fall below the shelf carved out at just above the $36 level then the USD/CAD rate could attempt to reach the falling 50-day moving average.

During the previous week, the US Fed’s actions sent the USD reeling but that all changed last week as the USD climbed out of the basement to the top of the heap. The USD was well bid all week as nearly half of the regional Federal Reserve presidents appeared more willing to support rate hikes than was the impression following the previous week’s Fed meeting and press conference by Janet Yellen. Of course, this may have been an attempt by the Fed to steer markets away from their post-FOMC conclusion that the Fed was safely out of the picture for the next few months. Thus, the regional Fed presidents were successful at injecting some speculation about the appropriate number of rate hikes this year and adding some uncertainty about a possible hike in the April or June meetings. Any time a regional Fed president is a little more hawkish or less dovish it is USD supportive.

Meanwhile, the GBP was at the bottom of the heap following the release of soft inflation data and an increase in the odds of the UK leaving the European Union in the June referendum in the wake of the Brussels terror attacks. With immigration as a key issue in the referendum, the GBP was knocked down as traders presumed that British voters might seek to distance themselves from the EU and the terrorist attacks that took place first in Paris back in November and now in Brussels. The February inflation reading added to the GBP’s pain. The 0.3% reading is unchanged on the previous month and was below the forecast of 0.4%.

Who let the Kangaroos out?

Who let the kangaroos out? It was that type of week, a risk-on rally. The risk-on currencies are led by the commodity currencies of the AUD, NZD, and CAD as it was a banner week for this lot as funds poured into the high yielding currencies. The GBP was able to slip into that club last week as it traded higher, despite the weakness of U.K. data. The GBP demonstrated incredible resilience as it corrected its oversold condition as Brexit fears abated, for now. As you can imagine, during bouts of risk-on trading the low yielding currencies or funding currencies would be the laggards and that is exactly what transpired last week. The low funding currencies of the EUR, CHF, JPY, and USD were at the back of the pack.

The AUD had its best week since October, having gained over 300 pips on the week. It wasn’t purely driven by the risk-on condition of the market, positive Australian economic data also helped. The Australian economy grew 0.6% in Q4, as consumer spending, housing construction, and public sector expenditure offset a fall in company investment and profits and export prices. The growth rate, which equates to 3% year-on-year and 2.5% for 2015, came in at the high end of economists' estimates. A smaller January trade deficit (A$2.94 bln vs. A$3.2 bln consensus) and a rise in the service PMI (51.8 vs. 48.4) also helped to lift the AUD. The Aussie also received a helping hand from the Reserve Bank of Australia, which left rates steady as widely anticipated. However, the most impressive aspect of the AUD’s performance is that it happened despite continued weakness in the China's PMIs last week.

Technically, the AUD could extend its recent strength as the risk-on theme of the market continues to run its course considering that there are no major U.S. economic reports on the calendar in the upcoming week; and against the backdrop of potential central bank easing from the ECB (March 10th) and Bank of Japan (March 15th). This also applies to the other commodity currencies of the NZD and CAD – they could move even higher along with the risk-on rally. Having said that, the momentum indicators are starting to show signs of over extension and warn of a possible correction or change in trend. The potential turning point may come from the US Federal Reserve meeting on March 16th. The Fed is not expected to hike interest rates but there has been enough improvement in the jobs report for the Fed to maintain a hawkish bias. This, in turn, would have the potential of turning the risk-on rally into risk-off.

The best performing currency last week was the CAD?!

The CAD was the best performing currency last week and it is has completely reversed its year to date performance from a negative to a positive gain since the Bank of Canada’s decision to keep rates on hold in mid-January. The CAD’s reversal of fortune can be attributed to firmer price of oil, stable equity markets, and to better economic performance with Canada’s biggest trading partner the USA. One prominent Canadian bank has gone so far as to proclaim that the worst is probably over for the CAD.

Looking at the daily chart of the CAD, there is good support around the 1.33 level and resistance around the 1.40 level. This trading range should contain future price action as long as the Canadian economy stabilizes, the price of oil continues to trade above the $30 range, and that the Bank of Canada remains on hold.

The stress factors that were driving the price action in the currency, bond, and equity markets from the start of the year have ebbed, for now. Those stresses were the volatility of the Chinese yuan, the fall in Chinese equity shares, the downward pressure on commodities, especially oil, and the fear that the US economy was showing signs of a recession. The fact that the CAD was the best performing currency last week speaks to this – the relief of anxiety over the stresses. On the opposite end of the spectrum, the ebbing of the collective stresses have been replaced by a new one – Brexit, "British exit", refers to the possibility of Britain's withdrawal from the 28-country bloc known as the European Union (EU), hence the 3.7% decline in the GBP last week.

The previous Friday, Prime Minister David Cameron had reached agreement with other EU leaders on changes to the U.K.’s relationship to the bloc. He laid out the key arguments he plans to use in his campaign, arguing that Britain is better off in terms of economic and national security within the EU, the destination for a significant portion of the U.K.’s exports. The GBP was actually buoyed by the agreement. However, the GBP quickly changed course and its losses accelerated after Boris Johnson, London’s mayor and one of the U.K.’s most prominent politicians, said he would campaign for Brexit. Johnson, a contender to become prime minister one day, is now the most high profile politician to back the “leave” campaign ahead of a referendum, now set for June 23.

How bad was the GBP’s fall last week? – it was down more than 500 pips, slicing through 30-year generational support at the 1.40 level. Since 1986, the GBP has experienced only 3-4 periods below $1.40. Was the move warranted? Frankly, no one is certain what Brexit would mean for the UK and Eurozone economies (after all, it’s never happened before), so because of this uncertainty traders tend to sell first and ask questions later. Last week’s losses have left the GBP technically oversold, and we should expect some sort of relief rally – although more selling would not be unusual.

Brexit would most certainly lead to Scotexit - Scotland exiting the United Kingdom. For the rest of Europe, the threat of Brexit has also opened up a Pandora’s box of fears about EU itself. If Britain did leave the EU it would open up the door to other EU countries which are unhappy with the current union. Little wonder then that euro has been drifting lower along with the GBP as investors grow increasingly wary of the whole region. Hyperbole you say! Then why did this weekend’s G20 warn against an exit from the EU?

Gold Wins by Default

The Japanese Yen was the biggest winner last week, surging despite negative fundamentals like the 0.4% decline in preliminary Japanese GDP for the fourth quarter. Despite all the gloom and doom, the Japanese yen has not only held its own against the strong US dollar, but posted a superb rally. How is this possible? Well, the Yen simply maximized its traditional safe-haven status, and global financial instability drove investors away from risk assets towards safer waters like the Japanese currency. The recent rush to safe assets will not last indefinitely however, and weak fundamentals will not fade away for this island country. Losers last week include, the Swiss Franc which experienced a retracement from the previous week’s gains.

On of this week’s major themes is the fact that an increasing number of central banks are employing negative rates – Europe, Denmark, Sweden, Switzerland and now Japan. What does it mean? And who’s next?

Well, negative rates signal slight desperation on the part of central banks. It suggests that traditional policy options were not effective and that new drastic measures are needed. Rates below zero also mean that there is minimal expectation of inflation and little to no anticipation of near-term economic rebound. How well negative interest rates have worked in the past is debatable, but most economists think they've had some success in Europe. Lowering rates has helped stem the appreciation of the Swedish and Swiss currencies and significantly pushed down the value of the Euro against the Dollar, which was a nice boost for exporters in the Euro Zone.

Well, negative rates signal slight desperation on the part of central banks. It suggests that traditional policy options were not effective and that new drastic measures are needed. Rates below zero also mean that there is minimal expectation of inflation and little to no anticipation of near-term economic rebound. How well negative interest rates have worked in the past is debatable, but most economists think they've had some success in Europe. Lowering rates has helped stem the appreciation of the Swedish and Swiss currencies and significantly pushed down the value of the Euro.

As for who is next, The Bank of Canada is the most likely of the major central banks to opt for negative rates this year, claims Marc Chandler, head of FX Markets Strategy at BBH. "I am not saying the Bank of Canada will, but that is the most likely candidate of those that are not there yet…” Canada's current overnight rate is already very low and the BOC has prepared markets for the possibility of negative rates by alluding to how they might work as a policy tool. Back in December, Stephen Poloz said the lower bound for the policy interest rate was around minus 0.5%. The bank will update its rate target on March 9.

In the US, it remains an open question whether the Fed will adopt negative rates in this environment. They seem to be enjoying a stronger economy than most, but everyone’s eyes will be on the data in coming weeks to see if it will warrant a drastic policy shift at the FOMC meeting in March. A change in economic circumstances could put negative rates “on the table” in the U.S., but unless the economy weakens significantly many analysts expect Fed policymakers to slowly raise rates, and not cut them. “I do not see this as anything but very low risk in the U.S." states Chandler.

In theory, rates below zero should reduce borrowing costs for companies and households, driving demand for loans. In practice however, a bank charging customers to hold their money, may cause cash to go under the mattress, or perhaps somewhere shinier...

It seems that the threat of negative rates across the globe has made Gold one of this year’s best investments. Negative rates, in simple terms, means that depositing cash will leave investors with less than when they started, making traditional assets such as gold more appealing. “Leave a million dollars with a bank, and in a year, you get only something like $990,000 back,” said Marc Faber, publisher of the Gloom, Boom & Doom Report. “I would rather want to own some solid currency, in other words gold.” All in all, when you have negative rates, something with a 0% yield becomes a high-yield asset and is therefore a nice place to park your money

Diminishing Returns

The carry trade continued to unwind last week. The Japanese yen, Swiss franc, and the euro have been used as funding currencies, due to their low or negative interest rates, were at the head of the pack. Market participants bought those currencies last week in order to exit their trades. The unwinding of the carry trade caused excessive volatility in financial markets. However, signs of stabilization in the equity markets were apparent in Friday’s price action. This was also reflected in the currency markets as the funding currency stopped rising and actually fell on Friday – perhaps signalling that the carry trade unwind had run its course, for now. We will know for sure as the new week opens and markets in most of Asia reopen after being closed for most of last week due to holidays.

It has been an extraordinary start to 2016. For the first couple of weeks the market’s anxiety revolved around the declines in the stock market and currency of China. It quickly changed to the oversupply of crude and its falling price. Then the market’s obsession turned to fears that the US economy was entering a recession. Before that obsession faded, along came the obsession of third party risk and troubled banks.

The financial sector is down about 15% year to date but Deutsche Bank is down more than 35% due to potential issues with its derivatives portfolio and its capital structure. Deutsche responded to the investor’s loss of confidence with a plan to back $5.4B in debt. The plan is so desperate it will even start buying back debt that was issued less than six weeks ago. Where have we seen this before? You got it – Lehman Brother in 2008. I guess we should have seen this coming back in June 2015 when the bank’s co-CEO, Anshu Jain and Jürgen Fitschen, abruptly resigned. We are not suggesting that this is 2008 all over again. However, sentiment has definitely changed since the Fed’s December rate hike as evidenced by the unwinding of carry trades.

Last week, Fed Chair Janet Yellen delivered a relatively upbeat assessment to the Senate Banking Committee. “A lot has happened” since December, when the Fed talked about raising rates 4 times in 2016 to kick off three years of sequential rate hikes, Yellen acknowledged. When asked about the risk of a recession, she responded that anything is possible but “expansions don’t die of old age.” She made clear that Fed officials were still debating when, not whether, they should raise rates again. She went on to play down the possibility that the Fed would seek to provide new stimulus by imposing negative interest rates. However, she refused to take negative interest rates off the table.

What we have here is a difference of opinion between the market and the central bank. The Fed expects the economy to continue to perform while it administers additional interest rate hikes; while investors expect the slowdown in the global economy will force the Fed to change course. The market is currently pricing in about an 8% chance that the Fed will lower rates by the end of 2016, compared with a 4% chance it will raise them, according to overnight-indexed swaps data compiled by Bloomberg.

Gold’s 16.76% rise year to date seems to reflect investors’ angst that central banks are out of ammo. The popular finance blog, Zero Hedge, recently put out a missive promoting that notion. They suggested that 8 years of monetary easing comprised of 637 collective rate cuts, $12.3 trillion in global quantitative easing, and with $8.3tn of global government debt currently yielding 0% or less

have been a “quantitative failure.” They insist that central banks have failed to revive the global economy and that every new measure yields less and less. They may be correct but we don’t think that central banks will stop. They continue to tell us that they have more tools in their tool box and we don’t doubt them – in fact, Ben Bernanke once talked about dropping money out of a helicopter. One thing that we are sure of is that every new tool used by central banks will lead to a corresponding move higher in the price of gold. Why you ask? – because Gold is the only currency that central bank can’t debase (create out of thin air).

Five and Counting

At the end of last week’s blog post, we mentioned that the central banks of Japan, New Zealand, and the USA would deliver policy announcements. We went on to say that no moves were expected by all three banks but if there was to be a move it would come from the Reserve Bank of New Zealand. On this count, we were half correct. There was a surprise move but it came from Japan not New Zealand, more on that later.

The big surprise of the week was the Bank of Japan adopting negative interest rates. The BOJ will charge 0.1% on any cash left on deposit with the bank. The yen responded with a loss of almost 2% on the week. This move shocked the markets because only a week ago Bank of Japan Governor, Haruhiko Kuroda, told an audience at the Davos World Economic Forum that he would not adopt negative interest rates. The bank’s policymakers, who voted 5-4 to approve the measure, took great pains to say the rate cut was based on global conditions and not the Japanese economy itself. It makes you wonder what the BOJ has seen that has changed their minds so quickly. It also makes you wonder why the Fed’s policymakers are not seeing the same thing.

The BOJ’s latest move makes it five and counting – i.e. five central banks that currently have a negative interest rate policy. The others are the ECB (-0.3%), Denmark (-0.65%), Switzerland (-0.75) and Sweden (-1.1%). We are emphasizing “and counting” because we believe that eventually other western central banks, including the US Fed, will have no choice but to adopt negative interest rates.

There were some changes in last Wednesday’s FOMC statement. The FOMC removed the line about the economy “expanding at a moderate pace” and replaced it with “growth slowed late last year”. They warned that market based measures of inflation compensation “declined further” and that inflation is expected to “remain low in the near term, in part because of further declines in energy prices.” The FOMC also explicitly said they were closely monitoring global economic and financial developments. These were nice dovish additions but we thought that the dropping of “risks being balanced” and the reference to being “reasonably confident” about inflation returning to 2% was more telling.

The changes to the FOMC statement reinforced what the market had already discounted – that the Fed's four rate hikes, as laid out in December’s dot-plot, are a fantasy. Before all the market turmoil in January, the fed funds futures were pricing in just two rate increases by year-end. The market is currently pricing in a single hike this year and traders see a 16% chance that the Fed will raise rates at its March meeting, down from 51 percent at the start of this year.

Looking ahead, it will be another busy week in the currency markets. The first trading week in February will see the release of Chinese PMI, UK PMI, RBA Rate Decision, German Labor Report, NZ Labor Report, BoE Rate Decision & Quarterly Report, US Non-Farm Payrolls, and the Canadian Employment Report.

Turning the corner?

The price action in the CAD and the GBP have demonstrated that a change in trend has occurred. The CAD had dropped for the first 12 trading days of the year. On Wednesday the losses stopped and the CAD went up for 3 straight days. The combination of the turnaround in the equity markets on Wednesday, the decision to stand pat on monetary policy by the Bank of Canada (also on Wednesday), and the 3 straight days of gains in crude oil (10.85% on the week) help cement the interim bottom in the CAD. Wait a second, I know what the regular readers of our blog are thinking right now – didn’t we say last week that the CAD had the potential to reach the 1.60 level due to the bust of the commodity super cycle? Yes we did and that is why we are calling last week’s bottom in the CAD as an interim bottom. Time will tell if this is the beginning of a correction before going to 1.60 or if it is a change in trend – the price action will determine that.

The price action in the GBP was also indicative of a turnaround. The GBP had steadily declined from the 2.090 level in early December until the about face in mid-week which broke the prevailing momentum. To further demonstrate this point, the GBP traded sharply higher on Friday despite a fall in retail sales that was three times larger than the consensus expected. When a currency rallies despite bad news this tells us that change is afoot.

Looking ahead, it will be another busy week in the currency markets. Along with the various economic reports due to be released, the central banks of Japan, New Zealand, and the USA will deliver policy announcements. No moves are expected by all three banks but if there is to be a move it will come from the Reserve Bank of New Zealand which could cut by a quarter point. After delivering its first rate hike in a decade, the Federal Reserve is not expected to make a move. However, it would be a total surprise if the FOMC statement did not contain a hint of concern over the recent volatility in equities and commodities. If it does then the USD will take a hit.

Congratulations to Dreamcatcher Meadows - Lordsley DMV places 4th (HOY)!

Dreamcatcher Meadows

Working Farm with Big Heart Attribute  Their Unparalleled Success to Unique Team; Overall Champion Sporthorse Breeder Title Third Consecutive Year – 2015 Adequan/USDF Annual Gala & Awards Banquet, Las Vegas

Dreamcatcher Meadows Ventures Ltd.(“DMV”), the unique sport horse breeding and training centre nestled in the Pemberton Valley near Whistler BC, captured a series of major equestrian sport titles, as well as declared 2015 Champion Adequan/USDF Sport horse Breeders of the Year – for the third year in a row!.  The top five home bred and trained horses, most owned by loyal sponsors, along with energetic residential teenagers, make up the  “team” earning awards so numerous a further surprise honour was presented by Dr. Ludwig Christmann, International Director of the Hanoverian Verband, travelling from Verden, Germany  to these elite equestrian awards in Las Vegas. Dr. Christmann presented both the owners of the hard-working farm Jill Giese and John Dingle and its primary sponsors , Leroy “Bus” Fuller and family (Earls and Joey Restaurants owning Ballerina DMV, Dancier’s Dream DMV, Wunderbar DMV, Wishing Star DMV and World Ruler DMV) with “Ehrenurkunde”, the state society certificates of recognition signed by the President, recognizing the  exceptional contribution recipients to sport horse breeding and competition with their Hanoverian breed horses. The top five horses also include DMV owned Equimat North America (sponsors od Highest Scoring Horse of the Year Leopold DMV and top three year old D-Trix DMV) and Tony Ma, President, Vancouver Bullion and Currency Exchange, owning the stunning stallion Lordsley DMV. (See awards list below)

John Dingle and Jill Giese, co-founders of the idyllic mountain valley farm, have devoted the past twelve years to turning a run-down cattle ranch into aptly named Dreamcatcher Meadows, ultimately providing horse services “from conception to competition”.  The pair attribute their meteoric success to their corporate sponsors.  DMV is seeking sponsorship for Leopold and D-trix, potential team talent for international competition. “We would rather not sell them and produce them for a Canadian to ride representing Canada – with a Canadian born and trained star.“ Obviously popular with two VIP tables of supporters at the Las Vegas awards, the Canadian breeding team won top spot by a large margin (97 points with 2^nd at 65!) against breeding operations owned by multinational corporations.

DMV Awards

 Perpetual Trophies

THE STALLION EXPO TROPHY  awarded to Adequan/USDF Dressage Sport horse Breeding Breeder of the Year ( Open to all breeders in  North American competing in USDF Breed and Material divisions. Points attributed based on up to five home bred horses placings in their individual age and sex group eg. Home bred Champion Material division earns 15 points, Reserve 14 points,etc.)

   Champion - DREAMCATCHER MEADOWS VENTURES LTD;  wins this honour for third year in row with 96 total points won by homebreds”  based on          scores of top five home bred horses earning Horse of the Year placings.

Leopold DMV, Lordsley DMV, D-Trix DMV; Ballerina DMV and Dreammaster DMV; Res Ch. Maurine Swanson 69 pts.

THE SUNSHINE SPORT HORSE ASSOCIATION TROPHY –  awarded to Adequan/USDF highest scoring overall (3,4 & 5 year old THE SUNSHINE SPORT HORSE ASSOCIATION TROPHY - Highest Scoring Champion of all Material Champion

  s Overall

Champion is 4 year old Leopold LEOPOLD DMV , ridden & trained by John Dingle; owned (and for sale) by Dreamcatcher Meaows (Ballerina DMV was Champion all three years eligible when 3 , 4 & 5 years old)

Horse of the Year Awards ( (HOY )  (Top five placings of qualified horses in same age/sex division)

Material  (young horses ridden)

 Champion-Champion  Leopold DMV Median score  Stalllions & Geldings Materiale combined ages 4/5. Median score 87.1%

            Champion- D-Trix DMV Owner DMV Ltd; Rider: John    Dingle 3 year old Stallions/Geldings Materiale ; Median 82.7

            Res. Champion Ballerina DMV/ Mature Maiden mares

; Sponsored by Earl’s and Joey Restaurant fgri=ounder. 

Res. ChampBallerina DMV/ Mature Maiden mares

Mature Stallions Sporthorse Breeding

4th --Lordsley DMV-.  Owner:  Tony Ma, Vancouver Bullion & Currency Exchange;  – Median 80.9

            5^th Dreammaster DMV- Owner: John Dingle  Median 80.1

Geldings 3 year old

            3^rd D-Trix DMV

2015 Year End All Breed CHS (CHS) Awards Summary

(11 medals)

Owners:  Bus & Riki Fuller (3 Medals)

Dancier’s Dream DMV: USDF All-Breeds CHS Training Level Open Champion: Owner:  Bus and Riki Fuller Scottsdale Arizona;

BREEDER:  DREAMCATCHER MEADOWS VENTURES LTD. PEMBERTON BC

Wishing Star DMV: USDF All-Breeds CHS: DSHB Yearling Filly Champion;

 Owners:  Bus and Riki Fuller, Scottsdale Arizona;

BREEDER:  DREAMCATCHER MEADOWS VENTURES LTD. PEMBERTON BC

Wunderbar DMV: USDF All-Breeds CHS DSHB 2 year old Colts & Geldings Champion;

Owner: Shelley Evans; 

BREEDER:  DREAMCATCHER MEADOWS VENTURES LTD. PEMBERTON BC

Owner Tony Ma, President, Vancouver Bullion & Currency Exchange; Breeder DMV Ltd. ( (accepting on behalf of Mr. Ma

Champion Lordsley DMV: USDF All-Breeds CHS 4 /5 Stallions & Geldings Material

Reserve Champion; ES Dreammaster DMV, Owner DMV Ltd.

Owner:  Shelley Evans (1 medal)

Wonderful Dream DMV: USDF All-Breeds CHS: 3 year old Fillies Material Champion;

Owner: Shelley Evans Revelstoke BC;

 BREEDER:  DREAMCATCHER MEADOWS VENTURES LTD. PEMBERTON BC

Owners: Dreamcatcher Meadows Ventures Ltd.  (4 medals)

D-Trix DMV: USDF All-Breeds CHS 3 year old Colts & Geldings Material Champion;

USDF All-Breeds CHS DSHB 3 year old Colts & Geldings Champion;

Owners: DMV  Ltd

BREEDER:  DREAMCATCHER MEADOWS VENTURES LTD. PEMBERTON BC

Leopold DMV: USDF All-Breeds CHS 4 – 5 year old Stallions & Geldings Materiale Champion.  

Owners:  DMV  Ltd.;

BREEDER:  DREAMCATCHER MEADOWS VENTURES LTD. PEMBERTON BC

Westminster DMV: USDF All-Breeds CHS DSHB 2 year old Colts & Geldings Reserve Champion;

Owners: DMV Ltd.;

BREEDER:  DREAMCATCHER MEADOWS VENTURES LTD. PEMBERTON BC

A crucial Bank of Canada policy meeting in the week ahead...

Just as the previous week, risk aversion ruled last week causing traders to reach for their TUMS antacid. Some $5.7 trillion has been wiped off the value of world stocks in the first two weeks of the year. For the second week in a row the Japanese yen was the top performer. As we mentioned last week, the media incorrectly characterized the increase in the yen value due to it being considered as a safe haven flow, which it is not. The strengthening of the yen simply reflects the unwinding of the carry trade. The worst performer was the CAD which was dragged down by the nearly 10% drop in the price of crude last week.

The markets continue to be frazzled by slowing US and global economic growth (US 4Q GDP tracking 0.6%), collapsing commodity prices, renewed fears about China, heightened geopolitical tensions (Middle East, North Korea, etc.), and the first transition to Fed policy tightening in a decade.

With a crucial Bank of Canada policy meeting in the week ahead, we wanted to look at commodities and the CAD. The slowdown in China and the sluggish global economy has caused a collapse in commodity prices. This in turn has weighed on the commodity currencies of New Zealand, Australia, and Canada.

Whatever happened to the “commodity super cycle”? Wasn’t it supposed to last between 15 to 20 years? It can be debated whether the commodity super cycle started in 1998 or 2002; notwithstanding, the low in the CAD in 1998 was around the 1.59 level while in 2002 it was around the 1.61 level. We point this out because if you accept that the super cycle has indeed ended, then wouldn’t it be logical for the CAD to return to the level that the cycle began at, which was around 1.60 level?

The Bank of Canada policy announcement is on Wednesday January 20th. If you recall, a year ago the Bank of Canada surprised the market with an interest rate cut at its January 2015 meeting. We don’t think anybody will be surprised if the BOC makes a move at this meeting since the economy and Canada’s number one export, crude oil, are both reeling. The only surprise may be in the form of stimulus taken by the BOC. Governor Poloz has suggested on more than one occasion that he would consider an asset purchase program, i.e. Quantitative Easing (QE). Launching QE while the current bank rate is at 50 bps is not unprecedented, that’s exactly what the Bank of England did when it started its current QE program. The market is expecting a rate cut and if that occurs then the CAD may actually bounce higher in the short term as this option is already discounted. If the BOC opts for QE then the currency could fall more due to the money printing characterization of QE. No move at all by the BOC could inject even more volatility and losses for the CAD as it would be seen as the BOC being behind the curve. Whatever the move, the path of least resistance for the CAD in 2016 will continue to be downward; therefore, companies with CAD receivables or USD payables should hedge their exposure while companies with USD receivables or CAD payables could stay the course in the spot market.

Poorly communicated and executed

The biggest driver in the currency market last week was not monetary policy divergence but rather risk aversion caused by outright fear. Risk aversion went into high gear on worries over a China slowdown, sheer panic in the Chinese stock market, a sharp drop in the Chinese Yuan adding to current disinflationary macro environment, and uncertainty around further FOMC interest rate hikes in 2016. The global ramifications of all this led to stocks being sold around the world causing carry trades to be unwound thereby making the Japanese Yen the top performer. In fact, it was the biggest weekly gain in the Yen against the USD since August 2013.  The media always seems to characterise the unwinding of the Yen carry trade as a safe haven move, which it is not. The carry trades is a strategy in which an investor borrows funds in a currency with a relatively low interest rate such as the Yen and Euro, due to its current negative rates, and the converting and investing of those funds into a currency yielding a higher interest such as the AUD and NZD. The big moves in the currency market last week was due to the unwinding of the carry trade which caused the AUD and NZD to be sold so that loans in the Yen and Euro could be paid back.
 The week started with news that Saudi Arabia executed a prominent Shiite Muslim cleric during a mass execution of 47 people. This ignited a regional rivalry between Iran and Riyadh injecting volatility into oil trading. This was quickly followed by the worse than expected Caixin  Manufacturing PMI for China falling to 48.2 from 48.6 in November, which was down for the 10th straight month.  This revived the China slowdown fears causing stock markets across Asia to fall. Circuit breakers kicked in after sharp selloffs but by the end of Monday the Shanghai Composite fell nearly 7% and the Shenzhen Composite lost 8.25%. This in turn ignited fears of greater Chinese stock market losses as investors feared that the ban on sales by larger investors, which was scheduled to be lifted at the end of the week, would be extended. That 6-month ban had been imposed at the height of the Chinese stock market crash in August.

As one might imagine, heavy stock market losses caused the Yuan to weaken and the spread between the onshore and offshore Yuan to widen. At one point, the spread hit its widest level in more than four years after the central bank was suspected to have intervened in the onshore market to support the currency. It's also important to remember that prior to the big August devaluation, the two rates traded at virtually the same level. The difference between the onshore (CNY) and offshore (CNH) market is due to China's wish to try to internationalize its currency. As China began to open its economy, it wanted its currency to be used in the international market to settle trade and financial transactions, without however fully opening up its capital account. The drawback with this dual system is that offshore Yuan is free to trade in the open market while the onshore Yuan fluctuates within a tight band under the control of the monetary authorities. Thus, as the offshore Yuan sold off the central bank of China was forced into intervening in the onshore market to stop the currency from falling too quickly. The bottom line is that the gap implies that external market participants (international investors) are pricing in further weakening of the onshore Yuan.

When the western media sees the Yuan falling they are quick to jump on the devaluation theme with their headlines charging that China is devaluing the Yuan in order to boost its sagging exports.  Buried deep in their articles is the fact that China is spending its reserves to slow down the fall in its currency in order to combat capital flight. Data on Thursday showed China's foreign exchange reserves fell by the most on record last month, down $108 billion in December alone and by $513 billion overall last year. This is a serious rundown in reserves and it cannot go on forever. The depletion in reserves causes monetary tightening, which in turn compounds their economic downturn. In theory, China could cut the reserve requirement ratio for banks (RRR) from its current 18%. This would ease monetary policy but it would also weaken the currency, which in turn would accelerate capital flight. China is trapped in a vicious circle - no country can have an open capital account, a managed exchange rate, and sovereign monetary policy - something must give.

As if market sentiment wasn’t fragile enough, the US Geological Survey detected an unusual 5.1magnitude tremor near a known North Korea nuclear test center. The North Korean regime announced it had successfully carried out its first underground test of a hydrogen bomb - a weapon much more powerful than an atomic bomb. Even though many experts discounted these claims, the test was enough to fan more panic and risk aversion.
By Thursday, China allowed the biggest fall in the yuan in five months sending global stock markets
tumbling as investors feared it would trigger competitive devaluations. And for a second time during
the week, another 7% crash in Chinese stocks in the first 30 minutes of trading caused circuit breakers to kick in and suspend trading for the rest of the day. It became very clear that the ending of the 6-month sales ban for large investors and the new circuit breaking mechanisms for halting trade in volatile markets were feeding on to itself by creating panic. It took a while, but authorities finally realized what was happening and they responded by abandoning the new circuit breaking mechanism and by replacing the sales ban with a less severe rule – large investors would be restricted from selling more than 1% of a listed company's share capital every three months. 

These measures finally helped to calm the markets; however they were poorly communicated and
poorly executed. In our opinion, Chinese financial markets lack a face – someone market participants can turn to for answers. In a well-developed market like in Canada, USA or the Eurozone, market participants can turn to a Stephen Poloz, Janet Yellen or Mario Draghi. They do a very good job of communicating their intentions. China doesn’t have a person that does this; they set out their intentions with press releases, which just doesn't cut it in a time of panic.

China could soothe markets by clearly communicating their monetary objectives. They need someone to say something like this – the central bank of China is in the process of normalizing monetary policy by slowly allowing interest rates to fall. The word "normalizing" would show that it is on the same page as the US Federal Reserve since they are normalizing their monetary policy by slowly allowing interest rates to rise. They could remind the markets that the Yuan has gained by about 30% on a trade weighted basis since 2011 and for the current state of their economy the Yuan is overvalued. China is in the midst of an economic slowdown and they are trying to engineer a transition from an export mercantile based economy to an internal consumer driven based economy that requires monetary easing. This, of course, will weaken its currency against countries that have a neutral or tight monetary policy. If they could have someone consistently bang out that message then fear over opportunistic devaluations would be dispelled and there would be less volatility in all markets.

       

 

    

Annual Round-up

The CAD was the worst performing currency of 2015 as it lost over 16% on the year while making 11- year lows. The Canadian economy suffered a technical recession in the first half of the year. The Bank of Canada responded with two interest rate cuts early on which seemed to help the economy get back to at least flat growth. The biggest culprit, as you can pretty well guess, was the crash in the price of oil. Unfortunately, the price of oil has not bottomed yet. With the Iranian sanctions coming to an end, more oil will be added to the current supply glut, which is also increasing thanks to the mild winter season in North America due to the warm El Nino weather pattern. With oil currently trading around the $37 handle a fall to $20 could be in the cards. If the price of oil does fall further don’t be surprised if the Bank of Canada offers up more interest cuts and possibly unconventional policies such as negative rates and/or QE, if things really go downhill. As we have seen with other central banks, dovish monetary easing doesn’t necessarily translate into an increase in a country’s exports especially when the world is struggling with insufficient global demand – thus some central banks have been forced into the use of unconventional policy tools.

The USD powered ahead for the first three months of 2015 on the premise that the U.S. Federal Reserve was getting ready to raise interest rates while the rest of the world was just kicking off another round of monetary easing. While this monetary policy divergence was well telegraphed, and thus easy to prepare for, it was the unexpected moves that caused the most damage. The breaking of the Swiss franc/euro peg in January and the Chinese yuan devaluation in August caused market participants undue stress and reminded everyone that forex markets are not for the faint of heart. 

Come to think of it, the policy divergence theme was also full of false starts as the Fed tied any rate increases to economic improvement amid signs of an inconsistent recovery. The market was blindsided when the Fed downgraded its predictions for U.S. growth and inflation at the March FOMC meeting instead of raising interest rates for the first time since 2006, sparking a selloff in the USD. This sapped the momentum from the US dollar index as it peaked in March and fell prey to false starts after each of the next four meetings. The second last meeting of the year in October was the turning point for the USD as it gained strength in anticipation of a December rate hike. Unfortunately, the USD was side swiped once again after ECB President Mario Draghi under delivered at the ECB policy meeting. A massive short squeeze in the EUR/USD ensued, which temporarily put a dent in the divergence theme. This helped to temper the market’s reaction to the Fed’s rate hike in December.

There is no question that the USD was the top performer of 2015, led by the divergence in monetary policy between the Fed and the rest of the main central banks. Now that the Fed has its first rate hike under its belt it is looking to make four additional hikes in the year ahead. The Fed will have more hawks in the birdcage in 2016 so the case for monetary tightening and a higher USD can easily be made. However, the divergence case may have a short shelf life since we think that the global easing cycle is nearing an end. How this plays out remains to be seen as each of the other central banks and foreign governments will have their say as well. Let us take a brief look at the majors.

The Japanese yen was the best performing currency after the USD. The yen was sought after as a safe haven during geopolitical events such as the Paris terrorist attacks. It also remained strong because the Bank of Japan did not find the need to offer any new easing policies. At this point, the only way we see the BOJ adding to its easing bias is if the fallout of the Chinese slowdown takes a turn for the worse. As we will shortly see, this wild card will be in play for many of the world’s central banks.

The one thing we can say for sure about the National Bank of Switzerland is that they are not ready to throw in the towel on keeping their currency from appreciating. They may change the goal posts from time to time, like they did in early January, but they are not about to quit. The biggest threat to currency appreciation would be a slowdown in the Eurozone economy which would cause the ECB to act again. Thus, the central bank could go further into negative rates if the circumstances warrant it.

The UK economy was one of the best performing economies in the first half of 2015 which caused many to believe that the Bank of England would be the second major central bank to raise interest rates. However, the economy tailed off in the second half of the year as the commodity sector continued to crash causing the market to push out the BOE’s interest rate hike. The greatest risk to the GBP in 2016 is the threat of Brexit - "British exit". Brexit refers to the possibility of Britain's withdrawal from the European Union. Prime Minister Cameron has promised a referendum but no date has been set as of yet. Leaving the EU would have an enormous economic impact on the UK economy, thus Brexit is a black cloud over the future.

The euro was down about 10% for the year but was able to hold its March low prior to the December ECB meeting which caused it to move up on a classic short squeeze. The fact that the Eurozone continues to struggle after the great financial crisis of 2008 and the European Sovereign debt crisis of 2010 is not surprising and only reinforces the problems with a currency union. The biggest drawback of the union is that they only share a currency but not revenue and taxation policies. Be that as it may, the ECB has done what it can to stimulate growth and it will continue to do so in 2016, considering it was the last one to the global easing party. Geopolitical risks in the Ukraine and the Middle East will continue to be the black clouds over the Eurozone in 2016.

The AUD and NZD were down 10.72% and 12.35% respectively for the full 2015 year. However, those numbers are misleading because for the last 3 months of 2015, the NZD and AUD were the top performing currencies with gains of 6.76% and 3.87% respectively. These gains came despite continued commodity price pressures in Q4 2015. In the first nine months of the year, the two commodity currencies struggled due to the high USD and the slowdown in the Chinese economy. The central banks of both countries responded with interest rate cuts and good old fashioned jawboning. By the time the fourth quarter started, both banks made it abundantly clear that they were satisfied with their country’s economic progress signalling the end of monetary stimulus. Coupled with a bottoming of key commodity prices for each country in the month of December - dairy for New Zealand and iron ore for Australia – the way was cleared for a rally into year-end for both currencies. The key for each currency in 2016 will be the performance of the Chinese economy. If China continues to sputter than both currencies will suffer. On the other hand, if China begins to turn the corner then both currencies will finish 2016 on a positive note. In either case, the NZD should outperform its commodity brethren, the AUD, due to its greater exposure to the Chinese consumer in the form of soft commodities (food) rather than hard commodities which are more geared to the investment and infrastructure side of the Chinese economy.

So there you have it, a brief synopsis of each of the key currency majors that we follow. We have taken for granted that we have entered into the second phase of monetary policy divergence. This phase will be marked by interest rate hikes by the Fed while other central banks stand pat or extend easing. It will be interesting to see how long this divergence lasts, considering that on the surface; it would seem that we are closer to the end of the global easing cycle rather than the middle. Once the Fed hints that it is close to ending its course of rate hikes then and then will the USD crest and turn downward.