The collapse of the loonie, recession and banking crisis risk
The Canadian dollar fell to 11-year lows.
The canadian dollar has now depreciated to 1.33 despite the short covering spike in the euro and the People's Bank of China rate cuts.
The canadian dollar has now depreciated to 1.33 despite the short covering spike in the euro and the People's Bank of China rate cuts, (as if rate cuts and RRR tweaking means squat at a time when the Middle Kingdom grapples with deflation!). While Chinese equities, crude oil and the loonie rallied after the gnomes of Beijing rolled out their latest monetary stimulus, the grim reality is that this is no panacea to China's credit/banking/property/equities bust in the coming decade.
The three-mbd crude oil glut and Saudi Arabia's refusal to respond to Iran/Algeria's pleas for an Opec "swing producer" cut tells me that Brent crude could well fall again to $40 a barrel, especially since refinery maintenance season cuts crude demand in October. Permian Basin and North Dakota shale oil drillers hedged with oil swaps at $80-$90 crude last winter and breakeven marginal costs have fallen to $28. The Toronto money markets price in a 25 basis point cut in the next 12 months. This is entirely possible since Governor Poloz and the Bank of Canada are desperate to boost Canadian manufactured exports to offset the loss of crude oil earnings, 25 per cent of exports.
This is the real reason the loonie, a classic petrocurrency like the Norwegian kroner and the Russian rouble (but not the pegged Saudi riyal!), fell to 11-year lows. This is the precise macro relationship, as well as Bank of Canada policy choices and relative US/Canuck interest rates spreads, that anchored my strategy call to short the Canadian dollar at 1.06 in mid-2014. This strategy call was a money gusher for so many friends of mine in the Gulf (snowbirds in the desert - the Gulf is the new Bahamas!) and, of course, the most exclusive golfing clubs in Montreal.
The loonie collapse, to me, is a ominous canary of global deflation risk, though Ontario/Quebec's debt binge and an ultra-dovish central bank governor helped make this strategic trade idea such as a phenomenal success. It is only a matter of time before the Bank of Canada cuts rates again and even embraces unorthodox monetary policy. Political risk in Alberta and the Federal election in October are also loonie negative. The Canadian "technical recession" will only deepen this fall. I expect a China hard landing and at least another 10 per cent fall in the yuan. This is a disaster for the loonie since the PRC is Canada's second largest trading partner. If oil prices fall to $32 as Citi predicts, the Canadian dollar could fall to 1990s lows near 1.45. It is insane to bottom-fish in the Canadian dollar.
US money centre banks were the darlings of Wall Street in 2015, with Citigroup, JPMorgan, Bank of America and even Goldman Sachs scaling all-time highs. Then came the China yuan shock, Armageddon in global equities, a plunge in US Treasury yields on safe haven flows, hedge fund unwinding, post earnings profit taking and margins calls on leveraged speculators. Every interest rate sensitive bank on Wall Street was shredded as former US Treasury Secretary Larry Summers even called on the Yellen Fed to ease, not tighten.
Despite the tightest labour market in a generation and post-crisis highs in auto sales/housing starts/credit card debt, the Fed cannot ignore the vicious cycle of 25-year correlation highs between crude oil's free-fall, King Dollar, Shanghai/Shenzehn, Asian/emerging markets currencies and epic volatility on Wall Street. To use Fedspeak, I can think Janet Yellen is "one and done" this autumn, with China and low inflation break evens as her rationale.
What will be the impact of mining/energy credit risk on Canadian banks, viewed with good reason as among the stablest credits in the Western world? Not benign! The Fed Funds futures in the Chicago Merc price in a February rate hike now. US Treasury two ten forward swaps have plunged to 250 basis poiints now. The world again learns the hard way that the yield curve flattens in times of systemic stress and a spike in the Chicago Volatility Index. This makes Alberta/BC/Saskatchewan boonie banks (regionals) and Canadian life insurers are a no-no for investors.