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.