The Dust Has Settled

 

 

Canadian employment surged last month, as the economy added the most jobs in over seven months. The best part of this news is that employment came everywhere, which is exactly what policymakers like to see. Canada recorded a net gain of almost 59K jobs while analysts had been expecting a net gain of a 10K with the full- and part-time almost evenly split (31K and 28K respectively). The unemployment rate stayed the same at 6.8%. After experiencing dramatic declines last year due to plummeting commodity prices, employment in Canada finally looks to be trending higher. More good news is that manufacturing jobs outside the commodity sector buoyed the employment report.

 

According to Bloomberg, "Canada added six times as many jobs in May as economists predicted on the biggest manufacturing gain in four years -- the kind of progress the central bank says is needed to foster a

recovery from the shock of lower oil prices. The strength counters other recent setbacks – shrinking Q1 output, record trade deficits, slow inflation – and supports Bank of Canada Governor Stephen Poloz's view that momentum is shifting to non-energy companies as the oil industry cuts investment and jobs."

 

It’s important to note that some of gains in May were driven by self-employment, but paid employment was still up by a healthy positive 37K. CAD bulls would suggest that last week’s jobs figures is a sign that the Canadian economy is shrugging off any set-back from its first quarter. On the flipside, aside from the rate divergence argument, USD bulls will also lean on how erratic Canadian jobs report can be. If you’re someone who manages your company’s USDCAD exposure, it’s important to remember that ‘one’ headline print is not a trend, so do not look at one report in isolation.

 

In addition, while the labor market added jobs, consumer spending also rose. The Wall Street Journal reports that the retail sales figure came in at an annual pace of 3.1%, above the previous month's reading of 2.5%. After falling alongside the weakening labor market, consumer spending has recently begun to rise. Auto sales contributed the most to the consumer spending measure. The WSJ states, "The largest gain in dollar terms was a 1.5% increase, to C$10.24 billion, in auto-related goods, led by a 1.8% sales gain at new-car dealers. Excluding the auto component, Canadian retail sales rose 0.5% to C$32.22 billion."

However, despite that fact that the labor market and household spending are improving, productivity of the labor force is falling. In Q1, the productivity figure came in at a quarterly contraction of -0.1%, which is down from Q4 2014 revised reading of 0.3%, while also missing estimates for 0.2%. In recent months, the productivity measure has leveled off, seen below. As productivity declines, economic growth will continue to have trouble rebounding higher.

Canada's economy remains weak, but is steadily improving. Jobs are being added to non-energy related sectors which is aiding consumer spending measures. Increased jobs, however, are not translating to economic activity as much as it could, due to lower labor force productivity. Ultimately, the Canadian economy is improving, which should technically lead the loonie to higher ground in coming months.

 

 

From the Canada Mortgage and Housing Corporation, the trend measure of housing starts in Canada was 181,231 units in May compared to 179,524 in April, according to Canada Mortgage and Housing Corporation (CMHC). The trend is a six-month moving average of the monthly seasonally adjusted annual rates (SAAR) of housing starts. "The small increase in the trend was primarily driven by higher multiple starts in Ontario, the Atlantic region, and Québec. Despite month-to-month variation in multiple starts, CMHC expects builders will continue to focus on managing inventory of completed but unsold units — inventory that is still above historical average," said Bob Dugan, CMHC’s Chief Economist. "CMHC also forecasts slight moderation in housing starts in 2015 and 2016, reflecting a slowdown in housing market activity in oil-producing provinces that will partly be offset by increased activity in provinces that are seeing the positive impacts of low oil prices."

 

From a report for April, Statistics Canada demonstrates that contractors took out $7.8 billion worth of building permits in April, up 11.6% from the previous month and a second consecutive monthly advance. The gain in April stemmed from higher construction intentions in both the residential and non-residential sectors in Ontario.

In the non-residential sector, the value of permits rose 30.2% to $3.3 billion in April, following a 24.8% gain in March. Increases were posted in three provinces, led by Ontario, followed by Alberta and Newfoundland and Labrador. British Columbia and Quebec registered the largest declines in construction intentions for non-residential buildings. Construction intentions for residential buildings increased 1.2% to $4.5 billion, a third consecutive monthly advance. Gains were noted in Ontario, Quebec, Nova Scotia and Newfoundland and Labrador. The largest decrease occurred in British Columbia, which had posted a notable increase the previous month.

USD in Focus

 

　

Last week we mused that because the Swiss franc was able to nudge out the USD as the best weekly performer that it foreshadowed a brief pause in the USD rally. And that’s exactly what transpired; the USD corrected its strong two week rally with a four day losing streak until Friday’s strong U.S. jobs data arrested its decline. The outliers for the week were the euro, NZD, and the yen. The euro was the top performer last week as the long German bund and short euro hedge position reared its ugly head again (the last time it happened was late April and early May). The NZD sold off to a low dating back to August 2010 as the market is pricing in a 50% chance of an interest rate cut by the Reserve Bank of New Zealand on June 10. Meanwhile, the yen also reached a multi-year low dating back to November 2002 as the strong May U.S. nonfarm employment report caused the December Fed funds contract to fully price in one rate hike by the Fed this year.

 

Euro in Focus
 

The price action in the Euro was very volatile last week. It moved from a low of 1.0880 on Monday to a high of 1.1380 on Thursday, that’s a 5 euro move and it was all powered by the unwinding of the long German bund and short euro hedge trade. International holders of German bunds decided to sell their bonds and to buy back their euro hedges, which basically caused that massive short squeeze in which the euro rallied by five big figures.

More important is why the bonds are being sold. Two reasons, the first is that back to back Eurozone inflation of 0.0% for April and 0.3% for May demonstrate that deflationary pressures are easing, which in turn are causing investors to question whether the ECB will continue its newly minted QE program. The second reason is fear that the Greek crisis could unravel. Greece is refusing to maintain the status quo of pretend and extend – that is to say that they are not looking to have creditors loan them more bailout funds in order for them to service debt. The Greeks want debt relief. The trigger point last week was that Greece delayed a key debt payment to the International Monetary Fund due on Friday offering instead to bundle four payments due in June into a single 1.6 billion euro (£1.16 billion) lump sum which is now due on June 30. This might be a sign that Greece may be choosing to preserve what's left of its war chest if talks don't improve and default.

JPY in Focus

 

The other move that caught our eye last week was that of the JPYUSD to a multi-year low at the 125 level. The decline in the yen suggests that traders are once again speculating that the Japanese currency will continue lower and, indeed, the recent CFTC Commitment of Traders data shows a dramatic increase in bearish bets on the JPY (bullish JPYUSD positions). In the past two weeks, net yen shorts have risen to 86K from 22K. This week’s revision to Japan’s initial Q1 GDP estimate will be the key market moving event. Revisions have been consistently higher than the original estimate so if it also happens on this one it could pour cold water on those looking for more QE which could induce a period of short covering.

 

 

   

An Air of Optimism

　

With the CAD ringing in its best weekly performance in four years, the question on the desk and with our clients is – is the bottom in? We will answer that in a moment. The CAD was up on a combination of less than stellar US economic data, firming Canadian economic data, a less dovish Bank of Canada, and a firmer oil price.

The Canadian economy seems to have gone from an "atrocious" first quarter as described by BOC Governor Stephen Poloz to an air of optimism. Canadian retail sales racked up their biggest increase in eight months for the month of February while core inflation saw its fastest pace in 6 years. This helps to explain why the BOC upgraded their assessment of the domestic economy. They revised Q1 GDP to flat from 1.5%, but Q2 was revised up to 1.8% from 1.5% and Q3 to 2.8% from 2.0%. Overall, the BOC sees 2015 growth at 1.9%. They also upgraded their inflation outlook which indicates that they see the oil impact mostly behind them. All in all, the BOC’s more optimistic mood has pretty much ruled out the chance of another rate cut this year.

The over 50% hair cut in the price of oil has been the main culprit in the roughly 16% decline in the value of the CAD since mid-2014. The price of oil surged about 8% last week, hitting a 2015 high of $57 at one point. The price action has the earmarks of a reverse head-and-shoulders bottoming formation. With the price of oil slicing through the neckline the technical analysis demonstrates that the price of oil has now bottomed. Ironically, this comes at a time when inventories are growing at least three times more than had been expected. Be that as it may, the recent price action speaks volumes.

So has the CAD bottomed? During this year we have been ask many times by clients as to what level the CAD would fall to. Our response has always been that the level is unknowable, however, the one thing that we are sure of is that the CAD will find its bottom once the price of oil has bottomed.

 

USDCAD Big 5 Forecasts from earlier this year:

 

 

The USD was taken to the woodshed last week after another round of weaker U.S. economic reports drove it sharply lower against all of the major currencies. Since the Fed jettisoned "patience" from their FOMC statement it is understood that the Fed will be data driven. Last week’s uninspiring economic data (US industrial production, Empire Fed, and Fed Beige Book) is causing some market participants to wonder out loud if the Fed will actually raise interest rates at all in 2015. This has caused market sentiment to change dramatically in the past week with market participants now questioning if the rally in the USD is over. Furthermore, with the economic calendar a little on the light side this upcoming week for US data, there will be little in the way of the USD’s current downward path. The one thing that could change its path next week could be safe haven flows due to the renewed fears about the risk of a Greek debt default and possible exit from the euro.

 

Negotiations between the Greeks and the Eurozone are reaching its climax and the endgame is finally visible. Greek Finance Minister Yanis Varoufakis doesn’t really have any choices if no deal is struck: Greece must either accept the terms of the bailout or risk going bust. An article written by Simon Nixon for the Wall Street Journal nicely summarizes the current situation.

It’s still possible that Greece can remain in the Eurozone — though that is no longer the base case for many policy makers. At the very least, most fear the situation is going to get much worse before it gets any better. No one now expects a deal to unlock Greek bailout funding at this week’s meeting of Eurozone finance ministers in Riga — originally set as the final deadline for a deal. The new final, final deadline is now said to be a summit on May 11.

But among European politicians and officials gathered in Washington DC last week for the International Monetary Fund’s Spring Meetings, there was little optimism that a deal will be agreed by then. The two sides are no closer to an agreement than when the Greek government took office almost three months ago. "Nothing, literally nothing has been achieved," says an official. In fact, it is worse than that: so far, the bulk of Athens’ reform plans would actually cost money or reduce government revenues, according to Eurozone officials.

They say that when you add up all the government’s proposals, the budget surplus required under the current program turns into a 10-15% deficit while debt soars far above the 120% of GDP targeted for 2022. There is no way that the Eurozone — let alone the IMF — could disburse funds on the basis of such fantastical numbers.

The bottom line is that Athens won’t get any money unless it can reach a deal that satisfies the IMF that Greek debt is on a sustainable path and that it has a medium-term funding plan in place. The Eurozone won’t disburse its own bailout funds without a deal that carries this IMF seal of approval.

The IMF has agreed to streamline its demands, but that hardly diminishes the scale of the compromise required of Prime Minister Alexis Tsipras; even a slimmed-down deal will require either Athens to commit to an ambitious third bailout program or the Eurozone to agree to provide substantial debt relief—which it won’t until Athens can convince the Eurozone it is serious about reform.   

 

NSF - A Greek Tragedy

The correction in the USD index continues as Friday’s US nonfarm payroll showed that job growth collapsed to its worst level since December 2013. The US economy created only 126K jobs last month, which was significantly less than the 250K that was forecast. The report broke a streak of 12 straight 200,000-plus gains and employment gains for February and January were reduced by a combined 69K. The unemployment rate was unchanged at 5.5% while the labor-force participation rate fell to 62.7%, matching the lowest level in 37 years, as 96,000 Americans dropped out of the labor force in March. All in all, the disappointing report makes it more likely that the Federal Reserve will wait until the end of summer before raising interest rates for the first time since 2006. The news weighed heavily on the USD on Friday causing it to underperform against all the major currencies except one, the AUD.

Fundamentally, the USD will continue to be well supported by the dominate theme of the divergence of monetary policy between the Fed and the rest of the global central banks. The chart technical warns us that the USD has more room to correct in the short term. The daily chart of the US dollar index shows that the 5-day moving average remains below the 20-day moving average and that the momentum indicators have not found a bottom yet.

 

Over the next couple of weeks, Greece will dominate the headlines as it may not have enough cash to meet its debt obligations. Greece does not have the funds to repay €450m to the IMF on April 9 and also to cover payments for salaries and social security on April 14, unless the Eurozone agrees to disburse the next tranche of its interim bail-out deal in time. We assume that faced with a choice between a default to the IMF and a default to their people that the government will choose to not repay the IMF. If this happens it will be the first time a developed country has ever defaulted to the IMF. While the IMF will probably offer a short grace period before declaring Greece to be in technical default, Greece has other really big funding hurdles to face.

Greece also has Treasury bills totaling €2.4 billion that mature on April 14 and April 17. Most of this debt is sitting in Greek banks, which have been rolling over these bills with emergency funding obtained from the ECB, rather than demanding repayment from the Greek government. However, these two upcoming bills are different because at least €500 million is owed to investors outside Greece who are going to ask for their money back. This is where things could spin out of control – if Greece can’t pay, it would be a default. This would trigger clauses in Greece’s other debt obligations that would require immediate repayment of those debts as well. This has the potential to sends shockwaves around the globe, the ECB, and the remaining depositors in Greek banks.
Keep in mind that this would be similar to what happened in Cyprus as the ECB will force "bail-ins" on the depositors of Greek banks in order for the ECB to recover what is owed to them. We bring this up to demonstrate that Cyprus remains in the euro so it doesn’t necessarily mean that Greece will be kicked out of the Eurozone. However, Greece may choose to leave on its own accord or may be asked to leave by

the remaining members. Either way, the effects on the euro are uncertain to say the least. Initially, the knee jerk reaction will be to sell the euro but it could rise after the fact as markets deem the Eurozone to be stronger without its weakest link.