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

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.

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.

And we're off to the races

We want to bring to your attention something we believe has yet to be priced into the markets regarding the Canadian dollar. The CAD was able to claw back most of last week’s losses on the back of a rise in non-energy exports and pretty healthy jobs report. However, the market has been complacent about the possibility of a change in government on the October 19th federal election. Current poles show that it is a three way race with the left-leaning New Democratic Party (NDP) enjoying a narrow lead. The NDP’s platform includes an extensive social agenda and the imposition of a cap-and-trade system for carbon emissions, which could endanger the drive to a balanced budget and a potential threat to energy investment, at a time when the sector is already under tremendous pressure.

Thus, if the NDP continues to rise in the polls then international investors could start to worry, which could weigh heavily on the CAD. Furthermore, this past Wednesday the Bank of Canada decided to stand pat at the policy meeting in order to stay politically neutral ahead of the federal election. However, the BOC may be forced to cut the benchmark interest rate at the October policy meeting after the election if oil prices are below the BOC’s own forecast and if domestic data continues to weaken.

The key event next week is Thursday's U.S. Fed interest rate announcement. There is about a 30% probability of the first Fed rate hike since June of 2006. Stay tuned for both Canadian and U.S. retail sales and inflation data reports which will be announced before the FOMC committee meeting.

It's Official: Canada is in Recession

It’s Official: Canada is in Recession

From Business Insider:

Canadian gross domestic product unexpectedly fell 0.2% in May. This was worse than the 0.0% expected by economists.

"The economy has contracted in six out of the last seven months," BNP's Derek Lindsay noted. The resource-rich economy has felt the crushing pain of falling commodity prices as global demand for raw materials has decelerated. And relief doesn't seem to be coming anytime soon.
"We continue to see falling commodities prices weighing heavily on the economy, with mining, utilities, and manufacturing presenting biggest drags on the goods side," Lindsay said. And this probably means more easy monetary policy.

"The Bank of Canada is likely to read this report as supportive of their move to cut rates at their last policy meeting earlier this month," Lindsay added. "We expect further easing ahead, as investment and exports remain in contractionary territory and the economy remains vulnerable to a correction in housing and a pullback in spending due to high levels of household debt."

Here are the specific details from Stancan:

Manufacturing output contracts

Manufacturing output contracted 1.7% in May, following no growth in April.
Durable-goods manufacturing fell 2.4% in May, as almost all major groups lost ground. Notable declines were recorded in machinery, computer and electronic products, fabricated metal products and miscellaneous manufacturing. Non-metallic mineral products manufacturing was up.
Non-durable goods manufacturing was down 0.7% in May, primarily because of declines in the manufacturing of food as well as beverage and tobacco. Decreases were also posted in textile, clothing and leather manufacturing, chemical manufacturing as well as printing and related support activities. The manufacturing of petroleum and coal products and of plastic and rubber products advanced.

Mining, quarrying, and oil and gas extraction falls again

Mining, quarrying, and oil and gas extraction fell 0.7% in May, down for a seventh consecutive month.
Oil and gas extraction fell 1.0% in May, after decreasing 3.4% in April, mainly as a result of a decline in conventional oil and natural gas extraction. Non-conventional oil extraction was also down.
Mining and quarrying (excluding oil and gas extraction) was down 0.8% in May. A decline in metallic mineral mining outweighed a gain in coal mining. Non-metallic mineral mining (which includes potash mines) was unchanged in May.
Support activities for mining and oil and gas extraction increased 2.8% in May, after rising 9.6% in April, as both drilling and rigging services advanced again. The gains in April and May followed double-digit declines in the first three months of the year.

Wholesale trade falls while retail trade rises

Following a 1.6% gain in April, wholesale trade fell 1.0% in May. Declines were notable in wholesaling of machinery, equipment and supplies, miscellaneous wholesaling (which includes agricultural supplies) as well as motor vehicle and parts wholesaling. On the other hand, food, beverage and tobacco wholesaling and farm products wholesaling were up.
Retail trade rose 0.5% in May after a 0.3% decline in April, led by increases in the activities of building material and garden equipment and supplies dealers as well as electronics and appliance stores.

Construction grows

Construction grew 1.0% in May, as engineering and repair construction as well as residential and non-residential building construction advanced.
The output of real estate agents and brokers rose 2.1% in May, up for a fourth consecutive month.
Finance and insurance sector declines
The finance and insurance sector declined 0.3% in May. A decrease in banking services outweighed increases in financial investment and insurance services.

Other industries

Utilities declined 1.4% in May, down for a third consecutive month. Electricity generation, transmission and distribution as well as natural gas distribution were both down in May. Unseasonably warm weather was recorded in some parts of the country in May.
The public sector (education, health and public administration combined) edged down 0.1% in May. Declines in educational and health care services more than offset an increase in public administration.
Accommodation and food services were up 0.9% in May, in parallel with an increase in the number of overnight travelers to Canada.

Need even more evidence?

Here are Five stages of death of the Canadian dollar according to the Globe and Mail which include Denial, Anger, Bargaining, Depression and finally Acceptance...

From BMO deputy chief economist Michael Gregory and senior economist Benjamin Reitzes:

"With a view to final trimester Fed tightening this year, unmatched by the BoC, we look for the currency to continue to depreciate, averaging C$1.33 in October [meaning about 75 cents]. Political uncertainty heading into the Oct. 19 federal election and continued global oil price volatility (but along sideways trend) should reinforce the weakening trend. Presuming the absence of post-election policy uncertainty and more oil prices, we look for the Loonie to average a cent or so stronger by 2015-end."

Other news...

The top performing currency last week was the Pound Sterling (GBP) but the excitement builds this week as we may see further gains in anticipation of the three PMI’s; Construction, Manufacturing and Services. In addition, it will be the first time the Bank of England will simultaneously release its policy decision, the meeting minutes, the votes and their new macroeconomic forecasts. Early last month BoE Governor, Mark Carney, had stated that, “the British economy's strong momentum meant the decision on when to raise rates would come into sharper focus around the end of this year.” Therefore, there is a strong possibility that there will be at least one vote for an interest rate hike.

The worst performer last week was the Swiss Franc (CHF). The SNB, Switzerland's central bank, reported a loss of 50.1 billion CHF on Friday due to a policy change. Per Business Insider, the bank's foreign currency reserves underwent a major devaluation when it decided to abandon a policy to cap the value of the franc against the euro earlier this year. Since the SNB had been buying Euros to maintain an exchange of 1.20 Swiss Francs to the Euro, it pushed up the value of the Franc, devaluing the recently bought Euros.

If you’re wondering why the US Federal announcement had little impact on the on the market last week, it might be because “staff projections prepared before the June 16-17 policy meeting were inadvertently included in a computer file that was posted to the Fed’s website on June 29.”
How’s that for a spoiler! The projections saw the federal-funds rate averaging 0.35% in Q4 of 2015, then rising to 1.26% in Q4 of 2016 and finally 2.12% in the fourth quarter of 2017. That’s one hike this year and potentially four next year. The actual statement however was quite lack luster, as the central bank only made small changes to its monetary policy, being very careful not to suggest when exactly they will raise interest rates this year; September or December. A September hike is the heavy favorite among banks, analysts and traders alike, but they may have missed something…

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

We have an Agreekment

Greece’s Bailout Deal Explained with a Euro-Parable

The following parable pretty much explains the bailout deal reached late Sunday night. This actually made the online rounds back in December 2011, but it still applies today and isn't that much of an exaggeration. Enjoy!

It’s a slow day in a little Greek Village. The rain is beating down and the streets are deserted. Times are tough. Everybody is in debt. Everybody lives on credit. On this particular day a rich German tourist is driving through the village. He stops at the local hotel and lays a €100 note on the desk, telling the hotel owner he wants to inspect the rooms upstairs in order to pick one to spend the night.

The owner gives him some keys and, as soon as the visitor has walked upstairs, the hotelier grabs the €100 note and runs next door to pay his debt to the butcher.

The butcher takes the €100 note and runs down the street to repay his debt to the pig farmer.

The pig farmer takes the €100 note and heads off to pay his bill at the supplier of feed and fuel.

The guy at the Farmers’ Co-op takes the €100 note and runs to pay his drinks bill at the local tavern.

The tavern owner slips the money along to the local bookie drinking at the bar, who has also been facing hard times and has had to offer him bets on the horses using.

The bookie then rushes to the hotel and pays off his room bill to the hotel owner (he drank too much one evening and couldn’t drive home) with the €100 note.

The hotel proprietor then places the €100 note back on the counter so the rich traveller will not suspect anything.

At that moment the traveller comes down the stairs, picks up the €100 note, states that the rooms are not satisfactory, pockets the money, and leaves town. No one produced anything. No one earned anything. However, the whole village is now out of debt and looking to the future with a lot more optimism.

And that, dear readers, is how the bailout package will work!

Yes, we finally have a deal in Greece, but by many accounts it is not materially different from the deal(s) Greece rejected over the past few weeks. The fallout from the Greek street has been swift. Now Prime Minister Tsipras has to get to work convincing the Greek people that as difficult and long as the path ahead may be, it’s the only way out.

If you would like to read the Euro Summit statement, you can find it here. Its main points include:

 A "significantly scaled up privatization program with improved governance."

 "Ambitious pension reforms" and measures to make the system more affordable.

 General deregulation and liberalization of Greece's market economy, with areas such as pharmacies being opened up to more competition.

 A "rigorous review" of modernizing the Greek labor market.

 Depoliticizing the Greek governing establishment — it's a common criticism that Greece's government is riddled with cronies from whichever administration is in office at the time.

 Amending or rolling back some legislation that has been passed in Syriza's first six months in power, much of which ran against previous bailout deals.

Margin Call

Currencies were under a lot of pressure for the first three days of last week as safe haven flows into the yen and USD dominated due the continued uncertainty in Greece and China. By Thursday, safe haven flows subsided and gradually reversed as the slew of Chinese government measures utilized to stop the equity markets from falling finally took hold. For now, this helped to stabilize the market and allowed currencies to rebound against the yen and USD. Stability continued to take hold on Friday as a sense of optimism over a potential Greek deal emerged. Thus, the only two currencies that moved by more or less than 0.50% for the week were the AUD and CAD.

It’s not surprising to us that the two outliers for the week were the AUD and CAD because it’s become apparent that the turmoil in the Chinese equity markets, and the slower economic growth in China in general, have weighed heavily on commodity prices. The fall in energy (oil for Canada) and industrial commodities (iron ore and copper for Australia) show no sign of abating as of yet and will continue to cast a long shadow on the respective currencies.


New Zealand may be spared the brunt of the fallout as agricultural commodities are more insulated from economic downturns in general since people still need to eat. Having said this, the fall in the two currencies last week was all about monetary policy. In Australia, on Tuesday keeping interest rates on hold at 2% for the second-straight month. However, the Aussie fell anyway after Reserve Bank governor Glenn Stevens said "further depreciation (in the currency) seems both likely and necessary, particularly given the significant declines in key commodity prices”.

Meanwhile in Canada, the key driver in CAD weakness was the cumulative soft economic data on top of the prior week’s negative GDP growth for April. Speculation has risen that the Bank of Canada will deliver a rate cut at tomorrow's policy meeting. Frankly, we would be surprised if they choose to wait until their September meeting given the string of disappointing data and the characterization of its surprise January rate cut by Bank of Canada governor Stephen Poloz as an “insurance policy”.

As we pen this blog, we feel a sense of exhaustion over thinking about the deal between Greece and the Eurozone. After the last couple of weeks we think that everyone, including ourselves, is suffering from crisis fatigue – not just about Greece but the 30% drop in the Shanghai Composite index over the last 3 weeks and 20% drop in oil, just to name a few. All of this is resurrecting fears of deflation or disinflation again, which may kick off a new monetary easing race by central bank; like it did in January of this year. Therefore, central banks look to ease policy further or to leave rates lower for longer.

Whatever happens in Greece is critical for the week ahead in markets, but what transpires in China will matter for many more months. Why? Because it renews fears of downside risks to global growth. We mentioned last week that China’s array of policy measures to arrest the fall in their stock market reeked of desperation. Unfortunately, last week they had to deploy even more measures before the stock market was able to stabilize. This stability will only last a short while because the reason behind the plunge in stock is margin calls. Investment bank, Goldman Sachs, notes that China’s margin debt is the highest in history of global equity market and stands at 12% of the free float market cap of imaginable stocks. So when equity prices began to fall about 4 weeks ago, it set off a wave of forced selling of shares due to margin calls. And with more than 90 million "retail" investors involved in the stock market, more downside is expected due to forced selling created by margin calls. The fear for all of us is that the stock market crash will dent Chinese consumer sentiment and derail whatever economic momentum China has left, which in turn could spread and derail the global economy.

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.

Center Stage - Bank of Canada interest rate decision

 

　

The CAD will take center stage this week with CPI, retail sales, Bank of Canada rate decision and statement, BOC Monetary Policy Report, and BOC press conference. Last Friday’s Canadian employment report appeared good on the surface with the economy adding 28.7K jobs for the month of March, which was much stronger than the 1K that was expected. The unemployment rate also held steady at 6.8% versus a forecast for a rise to 6.9%. Below the surface, the headline number masked the underlying weakness as all of the job growth was in part-time work with the economy actually losing 28k full-time jobs. Since the beginning of 2015, the economy has added 104K part-time jobs and lost 30K full-time jobs. Furthermore, the employment component of IVEY PMI shows how the index has moved below the key 50 boom/bust line and has been in downtrend since November 2014.

 

Bank of Canada Governor Poloz has been nervous about Canada’s economy, and for good reason, as we have yet to witness the knock out effects of the steep fall in oil prices. He has described Canada’s first quarter performance as "atrocious" and even used the word "recession" when explaining why stimulus is needed. Poloz has proven with his cut at the January meeting that he is capable of surprising the market, so you can’t rule out a move. However, the downtrend in the CAD has done a lot of the heavy lifting that a cut in interest rates would deliver and crude has thus far stabilized around the $50 level. Thus, we believe that he will refrain from cutting rates, wishing to save his bullets for more desperate times, especially if the price of crude resumes its downtrend in search of a new bottom amid swelling oil inventories. Having said that, the CAD may not gain any traction from a pass on a BOC rate hike as the USD continues its bullish break out of its recent consolidation.

　
The week prior the AUD was the worst performer as it was weighed down by the expectation of an interest rate cut by the Reserve Bank of Australia; and when the RBA took a pass the AUD shot up to become the best performer last week on the short squeeze that followed. The second worst performer the week prior, the USD, became the second best performer last week as the market completely unwound the move spurred by the disappointing jobs data at the end of last week. The change in the market’s mindset appears to have placed the possibility of a June Fed rate hike back on the table. Last week’s release of the FOMC minutes and commentary by NY Fed Chief Bill Dudley, a well-established dove, suggested that the Fed was still considering the move towards normalization as early as this summer. This was all the USD bulls needed to hear to break out of its recent corrective consolidation. Lately, any normalization rhetoric by any Fed member (voting or non-voting) seems to fuel USD buying, making every anti-USD rally an easy sell for now.

A bombshell decline in Chinese exports percolated fears that global growth is losing energy and sent undulations through world currency markets on Monday. The USD strengthened for a third day as signals of cooling in China’s economy highlighted the diverging fortunes of the world’s two biggest economies. Figures showing the biggest drop in overseas sales from China for a year and a nose-dive in imports took financial markets by surprise.

The data from China’s General Administration of Customs showed its export sales shrank by 15% in March compared to a year ago and imports fell by 12.7% in a third consecutive month of declines, raising anxieties about wavering domestic demand. Economists had been expecting a 12% rise in exports – yes, you read that correctly! They said the surprise fall may point to weaker than expected first quarter economic growth from Beijing on Wednesday. The drop in exports left the trade surplus in March at $3.1bn, well below forecasts of $45.4bn in a Reuters poll of economists – a 93% difference.

The despair around the trade figures was compounded by the World Bank cutting its growth forecasts for East Asia, with Chinese growth revised down to 7.1% from 7.2% in 2015.

 

 

Curve Ball - Central bank heads of the U.S and Canada were at the podium last week

Last week the central bank heads of the U.S. and Canada were at the podium – Federal Reserve Chair Janet Yellen spoke at the semi-annual testimony to the Senate banking committee in Washington while Bank of Canada Governor Stephen Poloz delivered a speech in London, Ontario about "reinventing central banking". Unlike Yellen’s testimony, Poloz threw us a curve ball. The market was leaning heavily for another interest rate cut by the Bank of Canada at its March 4th policy meeting (didn't happen). However, those hopes were dashed when Poloz said "the downside risk insurance from the interest rate cut (in January) buys us some time to see how the economy actually responds." The CAD soared as the odds of a 25 basis point cut next week were cut from 72% to 38%. Poloz had been expected to sound a "dovish" tone but his curve ball put the central bank in wait-and-see mode.

　

Meanwhile, Yellen’s testimony was interpreted as dovish by the market even though we thought that she clarified the path to the Fed’s first interest rate hike since the 2008 credit crisis. Since the January FOMC meeting the market had come to understand that once the FOMC dropped or diluted the word "patience" from its policy statement that it could expect the Fed to raise rates after two meetings. In her testimony, Yellen further clarified this notion by saying that a rate hike could occur at any meeting after the forward guidance changed. We personally see this as a bullish development, but the market has read it as a dovish development. Most media outlets conveyed that this meant that once the word "patience" was removed that the Fed would become data dependent – duh! When hasn’t the Fed been data dependent? There is nothing new here; it will come down to a change in forward guidance and the next opportunity for the Fed to do that will be on March 18th. Thus, once patience is dropped, the count down for a rate hike will begin.

 

 

The USD has already gained considerable ground against a broad cross-section of other currencies, propelled by relatively strong U.S. growth and the divergent direction of monetary policy guidance from the Fed and the policy outlook for many other central banks. Now that the Fed has laid down the framework for a rate hike all data will be scrutinized as to whether it is positive or negative for a rate hike. Therefore, the USD is vulnerable to poor economic data and will move higher on good economic data. We had our first test last Thursday with the January CPI reading. Media headlines proclaimed that deflation had come to America with consumer prices falling by 0.1%. The decline in prices was almost all due to falling gas prices.

So this begs the question – can the Fed raise interest rates in the face of falling prices? We believe Yellen has already answered this question and took the opportunity to reiterate her position on this in her testimony by stating that the inflation impact from falling energy prices was temporary. We suspect that the plot will have a few more twists and turns with a busy data week ahead with US ISM manufacturing PMI and the non-farm payroll data.