Puzzled?

Earlier this month we speculated that the Bank of Canada could cut interest rates after the negative April GDP print; and in last week’s blog post we said that we would be shocked if the BOC didn’t cut because of the string of negative data point after the disappointing April GDP report. Faced with a firestorm of recession talk, the BOC had no choice but to cut interest rates by 25bp to 0.5%. The CAD was promptly sold hard to six years lows. The price action far exceeded our expectations especially after the BOC raised the possibility of QE, if necessary, indicating that this move may not be the end of its easing campaign.

Bank of Canada Governor Stephen Poloz refrained from using the R word by stating that "real GDP is now projected to have contracted modestly in the first half of the year." The BOC also lowered its 2015 growth forecast from 1.9% to 1.1%. For 2016, it expects the economy to grow by 2.3% versus a previous forecast of 2.5%. The economy is not expected to return to full capacity until 2017. As for inflation, the underlying estimate is now 1.5% instead of 1.7%. As you might imagine, the decline in the price of crude oil was the major culprit in the adjusted forecasts.

In the press conference after the policy announcement, Governor Poloz said two things that really
stand out and didn’t seem to receive enough press. He mentioned that he was puzzled that the weaker CAD failed to improve non-energy exports. This statement struck a chord with us because two other countries have had that similar experience. The weak yen has not caused a surge in Japanese exports. Similarly, the weak euro has also not caused an increase in exports as evidenced in the recent Eurozone May trade figures which showed that exports fell 1.5%. We are not sure why this would be puzzling – after all, central banks are engaged in a currency war and no country can gain an advantage if all central banks are counter acting other bank’s moves with matching simulative monetary policy measures.

The other thing that Poloz said was that he expected the Canadian economy to be less in sync with that of the U.S. Are the economic cycles of the two nations that much out of sync? Many economists certainly think so – according to a recent survey in the Wall Street Journal, 82% of economists expect a Fed hike in September. If that is the case, the CAD is in for way more downside that anyone currently expects.

Still the One

With Greece and the Chinese stock market off the front pages, safe haven flows subsided and the monetary divergence theme reasserted itself as the driving force in the currency markets. Last week, the GBP was the top performer as positive economic data, including accelerating employment earnings, and a chorus of Bank of England members sounding more hawkish about a rate hike. This caused the timing of a UK rate hike to move from Q2 2016 to Q1. Having said this, the U.S. is still the one. No, we are not referring to the 70s soft rock ballad by Orleans but rather the only major central bank that is on course to raise interest rates in 2015. Federal Reserve Chairwomen Janet Yellen was on Capitol Hill last week and she stuck with her script by reaffirming that the central bank was on track to raise interest rates this year. If you remember, this is the very same driving force that prevailed in January of this year as the rate hikers were the top performers while the rest of the countries were moving in the opposite direction.

Apart from the central banks of the US and UK, the other major central banks have either a neutral bias or are in easing mode. The ECB left its policy unchanged at last week’s meeting and reaffirmed that the conditions of low inflation remain. Thus, its policy of bond purchase will remain in place. The Bank of Japan also had its meeting last week and it adjusted its inflation forecast – it no longer expects to hit its inflation target until after 2018 which means that it may need to apply more stimuli in meetings to come.

China reported a slew of key economic indicators last week, including Q2 GDP. It announced that its quarterly GDP came in right on target at 7%, like it always does. However, this time the chorus of investors responding with disbelief was louder than ever. No one believes their data anymore. Leaving this aside, China will probably need to administer more stimulus but more importantly their economy is not growing like it was, which is putting tremendous pressure on commodity prices and the economies of the countries that produce them – Australia, New Zealand, and Canada. Australia was the best performer of the countries in easing mode mainly because their next central bank meeting isn’t until the beginning of August. New Zealand was the worst performer because their next central bank meeting is next Wednesday; and after last week’s disastrous dairy auction, the odds have increased dramatically that the RBNZ will cut rates by 50 bps instead of 25 bps.

Tony Valente
Fred Maurer

Oximoron

Teetering Technical Recession

Canada may be teetering on the brink of a technical recession as business investment plunged in response to slumping crude-oil prices. Last Tuesday, Statistics Canada released the April GDP report and it showed that Canadian real GDP contracted for a fourth consecutive month, with real GDP down by 0.1% in the month. Market expectations were for a 0.1% increase in April. The data is raising concerns in the economy’s ability to post growth of 1.8% in the second quarter, which is what the Bank of Canada is expecting. This is raising speculation that the BOC could cut rates as soon as its next meeting on July 15th, which would weigh heavily on the CAD.

The BOC cut rates in January as an “insurance policy” for the economic fallout in the plunge in the price of crude oil. Crude oil was under pressure last week due to the increase in drilling rig counts and the possibility of a near term deal between Iran and the USA which would put more supply into the market. As you can see from the chart, the price of oil has stabilized over the last couple of months but it is in danger of slipping below its lowest level since mid-April. If it breaches that level the next support would be around the $52 level. The BOC will be watching the chart below very closely and may be tempted to take out another insurance policy by way of a rate cut.

The CAD fell through the green trend line on the daily chart on the negative GDP news of last week. The downside stalled near the mid-April low around the 0.79 level. However, increase speculation on another BOC rate cut and continued pressure on crude could put the mid-May low of 0.7780 in play. There is plenty of Canadian data this week - Ivey Purchasing Managers index, Business Outlook Survey, Building Permits, Housing Starts, and Friday’s employment data.

The Japanese yen finished at the top of the leader board last week as the yen did what it always does in a risk off environment – it races to the top as it benefits from safe haven flows. Interestingly, the commodity currencies of Australia, Canada, and New Zealand were the worst performers, and they all under-performed for the same reasons – risk off, lower prices of key commodities, and potential monetary policy moves. Greece and the Chinese stock market selloff have pushed safe haven flows to the yen and USD. The AUD was weighed down by declines in the price of copper and iron ore; the CAD suffered due to the down draft in the price of crude oil; and the NZD continued to suffer from the ongoing decline in milk as the GlobalDairy Trade index declined for the eighth consecutive week. The commodity price and economic backdrop for all three of these countries is putting pressure on their respective central bank to make some near term policy moves.


Over the weekend China demonstrated that it is very nervous about the 30% decline in its stock market since June 12. The week before the Chinese central bank lowered its key one-year lending and deposit rates and cut reserve requirements. These moves failed to arrest the fall in the stock market so on Friday more measures were announced by various group – 25 mutual funds companies stated that they would actively buy stocks and hold them for at least a year, 21 brokerage firms said they would invest 15% of their net assets (about $20 bln) in the ETFs of high capitalization stocks, and finally no new IPOs were being issued for the time being. These moves reek of desperation. The other big news over the weekend is that Greece voted “no” in their referendum. What this means precisely is unknown and it will probably play out over the following week, but we’ll go into further detail below.

Greece: The Unknown Abyss

In a previous blog post "More Cowbell?", we talked about possibly scenarios that might play out with a “no” vote. Well, we’re here, and frankly speaking, absolutely nobody knows what’s going to happen in the near- and long-term. However, everyone does agree that something must happen very quickly. Allianz’s Mohamed El-Erian offered a brief preview of what will happen next as a function of three main things:

 Whether Greece and its creditors can work together to reconcile what were two very different interpretations in the run-up to today as to what a “no” outcome means, and do so very quickly and effectively;

 Whether already horrid conditions on the ground, including the high likelihood of further delays in re-opening the banks and significant difficulties getting fresh money into ATMs, provide enough time for the politicians to get their act together; and

 Whether the ECB rolls out new measures to contain contagion.

The fallout from the “no” vote has already begun as the embattled Greek Finance Minister, Yanis Varoufakis resigned. In a blog post, Varoufakis stated, “"I was made aware of a certain preference by some Eurogroup participants, and assorted 'partners', for my ... 'absence' from its meetings; an idea that the Prime Minister judged to be potentially helpful to him in reaching an agreement. For this reason, I am leaving the Ministry of Finance today." He continued, "I shall wear the creditors' loathing with pride."

Speaking of creditors, no discussion on Greek debt is complete without identifying who is owed. Currently, Greece’s public debt stands at €323 billion, which is nearly 175% of the country’s GDP. You don’t need us to tell you that this is completely unsustainable.

There are simply too many unknowns to get into a deep analysis of what might happen in the coming days and months. As we said earlier, the process must start very quickly and openly so that the markets find some stability. In addition, the last thing we want to do is misguide you as you make decisions on your personal or corporate exposure to FX, particularly the EUR. That said, we love an informed customer, so please call us at 604-685-1016, or email us at info@vbce.ca. We would be more than happy to give you up-to-the-minute information on what’s going on in the markets.

The FX Roundup

We did not see this coming. I’m not referring to the “ohi” (otherwise known as “no”) vote delivered by the Greek people (for you students of Modern Greek “ohi” is pronounced “o-hee” with a guttural “hee”). I am referring to the mandate delivered; a clear margin of victory for those rejecting the proposed austerity measures. While the market waxes and wanes some minor details need to be worked out, such as “Is the referendum binding?”, and “If so, how?” Maybe this whole matter needs to be kicked upstairs. As Axel Schaefer, a deputy head of the Social Democrats in Germany suggested: “EU leaders must get together immediately, even on Monday. The situation is too serious to leave to finance ministers”. This quote is so funny on so many levels we don’t even know where to start. We will say that we're calmed by the fact that it appears that someone important in Europe will be taking a look at this problem in the next 24 hours.


We will be bombarded with lots of news and commentary from all corners of Europe over the next few days so we think it’s better to keep our own powder dry with respect to addressing where we go from here. Greek Prime Minister Alexis Tsipras tweeted out “Today's referendum doesn't have winners or losers. It is a great victory, in and of itself…. The mandate you've given me does not call for a break with Europe, but rather gives me greater negotiating strength.” We will see about that in 6 months if after rejecting the bailout terms Greece teeters on the brink of total collapse before capitulating to something far more draconian than the deal on the table today.

Weekly FX Market Update - No Mas

 

Weekly FX Market Update - No Mas

 

 

The CHF turned in, not only its best performance in the week, but its best performance in modern history. The euro was at the back of the pack largely due to the fallout from the surprise move by the Swiss National Bank (SNB). The yen was up as the yen carry trade continued to unwind due to the continued downward move in global equities. The only reason the CAD didn’t finish last was because the SNB’s policy decision was more of a negative for the euro.

 

The SNB’s decision to abandon its currency cap against the euro on Thursday was reminiscent of one of the most famous fights in boxing history between Roberto Duran and Sugar Ray Leonard on November 25, 1980. At the end of round eight Duran turned away from Leonard and moved towards the referee and quit the match by saying, "No mas", which means "no more" in Spanish. The SNB’s policy of not letting the Swiss franc appreciate beyond the level of SFr1.20 per euro had been in place since September of 2011. They maintained this cap by printing unlimited amounts of francs and intervening in the currency markets by buying euros. This policy had caused the SNB’s balance sheet to balloon and represented 86% of Switzerland’s gross domestic product — far higher than the Bank of Japan (60%) or the Federal Reserve (25%). Why end the cap now? – the SNB must have been overwhelmingly convinced that the European Central Bank was going to announce Quantitative Easing (QE) next week. QE by the ECB will weaken the euro even more and the policy cap would require the SNB to buy even more euros so they threw in the towel and declared "no mas". 

 

 

The SNB’s decision drove euro down by nearly 40% against the CHF at the onset and had broader ramifications in the forex markets. By all accounts, the decision qualified as a black swan event because no one expected the SNB to scrap their 3.5 year cap which means that investors had not bothered to guard against it.

 

It caused some substantial foreign exchange brokerages out of business. It remains to be seen if any systemically important institutions have suffered leveraged losses.

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USDCAD jumps 3 cents / 6 year high on surprise Bank of Canada rate cut

VBCE Daily Foreign Exchange Update for Wednesday, Jan. 21st, 2015

USDCAD spot rate: 1.2365 - 1.2370 (AS AT 8:50AM PST)

 

RANGES:	Asia:	1.2076	to	1.2114
	Europe:	1.2078	to	1.2108
	North America:	1.2063	to	1.2387

Technical Support / Resistance:

S2	S1	R1	R2
1.2065	1.2200	1.2387	1.2504

Key Economic Data Releases:

-Bank of Canada interest rate decision: 0.75% (exp. unchanged @ 1.0%)

-http://www.bankofcanada.ca/2015/01/fad-press-release-2015-01-21/

-Canada wholesale sales: -0.3% (exp. -0.1%)

-U.S. building permits: 1.032 million (exp. 1.055 million)

-U.S. housing starts: 1.089 million (exp. 1.040 million)

Key Event Calendar:

DATE	CANADA	U.S.A.
Jan. 22		Jobless claims, housing price index
Jan. 23	CPI, retail sales	Markit mfg PMI, existing home sales

Yesterday, USDCAD traded from 1.1940 up to 1.2115, closing the session near the highs. The close above 1.1984 after 6 consecutive failed attempts to close above this key level opens the door for further upside from a technical standpoint. Overnight, the pairing eased to 1.2063 ahead of the 7:00am Bank of Canada announcement. The BOC shocked markets with a surprise rate cut sending USDCAD up to 1.2320. The pairing pulled back briefly to 1.2275 before climbing again to 1.2387 during the Bank of Canada press conference. The pairing has since pulled back to 1.2350. The Bank cites concerns over weakness in oil prices as the reason for the surprise move. The Bank comments that “there is considerable uncertainty around the outlook…real GDP growth will slow to about 1.50% and the output gap to widen in the first half of 2015.” The Bank also believes that the “economy to gradually strengthen in the 2ND half of this year, with real GDP growth averaging 2.1% in 2015 and 2.4% in 2016.” Currently, the TSX is up 1.90% while the DJIA is up 0.30%. EURCAD is up 2.6% trading between 1.3957 and 1.4360. GBPCAD is up 2% trading between 1.8213 and 1.8738. JPYCAD is up 3% trading between 0.01018 and 0.01052. Gold is down 0.25% trading between $1,284 and $1,305USD/oz, silver is unchanged trading between $17.91 and $18.48USD/oz, while oil is up 2.30%, trading between $46.31 and $48.17.

Sources: Reuters, Bloomberg, FXStreet, RBC Capital Markets, Bank of Canada, U.S. Federal Reserve, CNBC, Forexlive