The European Central Bank cut interest rates on Thursday and announced an aggressive, multi-pronged stimulus package. The ECB believes that the moves were necessary because the Eurozone economy and the outlook for the global economy has deteriorated since the beginning of the year.
Wednesday, the Reserve Bank of New Zealand cut interest rates as well. The RBNZ justified their actions stating; “The outlook for global growth has deteriorated since the December Monetary Policy Statement, due to weaker growth in China and other emerging markets and slower growth in Europe. This is despite extraordinary monetary accommodation and further declines in interest rates in several countries. Financial volatility has increased, reflected in higher credit spreads. Commodity prices remain low”.
The Bank of Canada policy meeting also occurred on Wednesday. They left interest rates unchanged. Where the ECB and the RBNZ see global economic deterioration, the BoC sees global growth strengthening
Who to believe?
Three central banks, two global economic views and one global economy. The ECB and RBNZ are concerned about further deterioration of the global economy. The ECB said that risks to Euro-area growth were tilted to the downside and lowered GDP forecast to 1.4% in 2016 and 1.7% in 2017. Inflation forecasts were also marked down.
The RBNZ was more explicit on its view of weakening global growth, singling out weaker growth in China as a major concern. They were also concerned due to a decline in inflation expectation measures.
The International Monetary Fund (IMF) also weighed in on the debate. On Wednesday, the deputy director, David Lipton, said “the IMF’s latest reading of the global economy shows once again a weakening baseline”. The IMF has already said that it may downgrade their global growth forecast, in April.
In contrast, Bank of Canada expects global growth to strengthen this year. Perhaps their view is clouded by the 0.8% jump in Canada Q4 GDP which beat forecasts of 0% growth. The optimists focused on the modest pick-up in growth in December (0.2%) while the pessimists pointed out that the outperformance in Q4 was due to a large drop in imports. The BoC is expecting that US expansion will benefit the domestic economy and do not appear to be bothered by inflation.
Someone is going to get it wrong and that someone may be the Bank of Canada.
The steep drop in oil prices since June 2015 created a host of global economic problems and there appears to be a growing consensus that the worst of the problem is over, supported by the 32% rally from the February low of 26.10/b. The news that Russia and Opec agreed to production caps and are meeting in Moscow on March 20, boosted WTI which touched $38.48 today. It also forced traders to unwind short oil positions.
Even the fundamental picture may be improving. The Energy Information Administration report released on Thursday, said that that there are signs that oil prices have bottomed out, citing possible actions by producers to control output, supply outages in Nigeria, Iraq and the UAE and signs that non-Opec supplies are falling. However, they did note that the risks are still to the downside. Crude Oil stocks inventories continued to grow and now, in the US, it is the start of refinery maintenance season which tends to reduce crude demand.
The rally in WTI drove the Canadian dollar back to mid December levels. WTI has backed off the overnight high which is getting close to strong resistance, represented by the June 2015 downtrend line (currently at $40.00/b) and the 38.3% Fibonacci retracement level of the June 2015-February 2016 range. ($39.59/b). A decisive move below $35.75/b would negate the uptrend from February and put the focus on a move to $30.00/b.
Stephen Poloz, governor of the Bank of Canada, readily admitted in his press conference on January 20, that he fully expected to be announcing a rate cut. He said that the high flying USDCAD rate (1.4688 just ahead of the announcement) was a key factor in the decision to leave rates unchanged. Despite a loss of over 0.1200 points, with USDCAD trading at 1.3400 on Wednesday, the BoC once again declined to cut rates. This time, they wanted to wait to see the impact of the proposed federal government fiscal stimulus plan that will be announced on March 22, 2015. The federal government is expected to announce $15-10 billion in infrastructure spending initiatives in an effort to jump start the economy. It could also boost the Canadian dollar. That wouldn’t make the BoC very happy. Wednesday’s interest rate statement credited the growth in non-energy exports to the exchange rate and that growth may evaporate with Canadian dollar strength. Would that be a reason to cut interest rates at the April meeting?
Between a rock and Uncle Sam
The Bank of Canada may get the forecast for global growth wrong but do they really care? Over 75% of Canada’s trade is with the United States and that economy is growing, as evidenced by the March 4, nonfarm payrolls report, consumer spending and low borrowing costs. GDP is expected to grow at 2.3% in Q1 2016 and 3.0% in Q2 2016. Just as a rising tide lifts all boats, a strengthening US economy bolsters the Canadian growth outlook. The current USDCAD downtrend below 1.3500 will be supported by improved sentiment from federal fiscal stimulus, improving domestic economic data and a neutral central bank. However, the prospect of lower oil prices and a hawkish US Federal Open Market Committee will temper USDCAD losses.
By David Marks, Agility FX Analyst