The Bank of Canada will not shadow higher US interest rates since the economy is in technical recession.
The Bank of Canada will not shadow higher US interest rates since the economy is in technical recession and GDP growth will be barely one per cent in 2015.
Published: Mon 12 Oct 2015, 12:00 AM
Last updated: Mon 12 Oct 2015, 9:14 AM
My strategic recommendation to short the Canadian dollar at 1.06 for a 1.30 target last summer was one of the most successful money-making strategies in the global foreign exchange market. The loonie fell to almost 1.34 by end-September 2015 before the recent rise in Brent crude oil, dovish Fed minutes and a synchronised rally in global equities have led to its rise to 1.2950.
Wall Street has scaled back its expectations of an aggressive Federal Reserve rate hike in 2015-16. The Chicago Fed Funds futures markets forecast a 30 per cent probability of a FOMC rate hike in December. I believe Mr Market is dead wrong. US nominal wage growth and economic momentum (payrolls, housing, consumer credit, ISM) means the dual mandate logic of the "data dependent" Yellen Fed necessitates a December 2015 rate hike. The Fed does not want or need to hike interest rates in the midst of a US presidential election to guard its political independence from the White House and Congress. This will be the first US interest rate hike cycle in nine years. In the 2004-06 cycle, Dr Bernanke raised the Fed funds rate by 425 basis points. I believe the next interest rate hike cycle will be at least 250 basis points, given current US growth and inflation metrics. As financial markets reprice their expectations of Fed "monetary normalisation", the US Treasury debt yield curve will both rise and steepen. This will lead to another major leg higher in the "King Dollar" rally.
The Bank of Canada will not shadow higher US interest rates since the economy is in technical recession and GDP growth will be barely one per cent in 2015. The slight uptick in Canadian exports to the US last summer will be offset by the growth shock in China, Brazil and South-east Asia. The energy/mining capex bust means financial distress for Alberta, Manitoba, Saskatchewan and British Columbia. The central bank in Ottawa will have no choice but to maintain its ultra-accommodative monetary policy even as the Federal Reserve tightens. This central bank monetary policy (and interest rate spread/economic growth) divergence means the primary trend for the Canadian dollar will be bearish in 2016.
The current bid in Brent/West Texas crude oil and battered mining shares can well take the short term loonie rate as high as 1.2800. The Canadian dollar will also face political risk if Conservative Prime Minister Stephen Harper does win a convincing majority in the Federal election. Canada will no longer attract cross-border capital from China in debt-financed energy and mining acquisitions, another component of loonie strength until early-2014. The fall in the US dollar to six week lows and Russian cruise missile strikes on Syrian targets from warships in the Caspian Sea have led to a sharp rise in crude oil, with West Texas now above $50 a barrel.
However, the existential reality of the world oil market is that Russia and Saudi Arabia are both producing above 10.6 mbd as both the Kremlin and the kingdom are desperate for hard currency petrodollar revenues to meet a spike in military budgets. Saudi Arabia will not play the role of Opec "swing producer" as long as the world's marginal barrel of oil comes from the Permian Basin in Texas and the Bakken in North Dakota, let alone offshore Mexico and offshore West Africa. As its spectacular fall in 2014-15 proved, the Canadian dollar is, above all, a petrocurrency.
The IMF/World Bank meetings in Lima do not increase my optimism on global growth, even if the Chinese yuan has stabilised at 6.34 to the US dollar - for now. I am convinced that the Volkswagen emissions software scandal will be a disaster for German export growth and auto/auto parts are 20 per cent of German exports. This raises the risk of a growth scare in Germany, one-third of the EU economy. German exports are under pressure in any case due to the economic woes of China/emerging markets. August saw the biggest drop in German exports since 2009. Das ist nicht gut!
This will limit euro strength and the euro is 57 per cent of the US Dollar Index. Deutsche Bank's shock $6 billion third quarter loss only reinforces my fears about the balance sheet black holes in European banking at a time when US money centre banks JPMorgan, Citi and BankAm are among the strongest, best-capitalised in the world. Fade the euro and the loonie on strength.
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