The 2016 trading year kicked off with a loud “Ka-Boom” when bungling Chinese officials sent waves of risk aversion rippling around the world. In a mere four days China implemented new equity market safe-guards, devalued the currency, crashed equity markets (home and abroad) and then suspended the brand new equity market buffers. As opening acts go, that is a grand finale.
China sneezes and world catches pneumonia
There is no doubt that China’s economic engine is sputtering. China’s GDP growth has missed official forecasts for the past three years and is on a slippery slide lower. The actual 2015 GDP growth rate is likely to come in a shade less than the official forecast of 7% while 2016 GDP forecasts are in the 6.5% area. To put it in perspective, China’s GDP is a Ferrari while Canada’s growth is “mini-van” and an old decrepit one at that. Nevertheless, the Chinese economy is slowing and the Chinese government’s actions to manage and mitigate the decline are wreaking havoc in global markets.
The steep equity market declines in the past few days are signs that local investors are worried about additional losses and the overall health of the economy. China introduced an new policy of “circuit breakers” on January 4, that were designed to manage equity market instability. The fact that the circuit breakers flipped on Day 1 was disconcerting but when it happened again, on Day 4, the doomsayers were out in force.
On Thursday, China suspended that system, an admission that they had fumbled the ball. Global markets got spooked as equity indices plummeted and traders shifted into risk aversion mode The “China Economic Slowdown” has been a key theme in global markets for the past two years and the currencies of Canada, Australia and New Zealand have been hit hard. The year is still brand new but until Chinese markets settle down the Canadian dollar will remain under pressure.
The fix is in
The CNY fix was lower than expected for the second day in a row on Thursday but fixed 0 .0010 points higher on Friday, an obvious stop-gap measure to help soothe markets. The CNY devaluations signal to traders that China is attempting to use the currency to help boost exports. Maybe so, but it is also a technical move. JP Morgan analysts suggest that the accelerated decline in CNY vs. the USD is a result of the Peoples Bank of China’s (PBoC) shift to a trade weighted index which they announced on December 11, 2015. They conclude that although the move may be a big step in exchange rate reform, it will lead to depreciation of other emerging market currencies and increase market volatility. Meanwhile, as long as the CNY fixes are lower than expected, the Canadian dollar will suffer, along with other commodity currencies.
Forget atomic, lets go nuclear.
George W. Bush was so afraid of Weapons of Mass Destruction that he sent the US Military to Iraq to find Saddam Hussein’s cache. They laid waste to the country, destabilized the region and didn’t find one WMD. They were in the wrong country.
North Korea said, on Tuesday, that they successfully tested a Hydrogen Bomb. Whatever it was, it sent a 5.1 magnitude tremor rippling throughout the area and also sent waves of risk aversion trading throughout financial markets.
And that was just icing on a cake that was baked on January 2. That was the day that Saudi Arabia executed 48 people including a Shiite cleric. The news wasn’t received very well in Iran. By the time the dust had settled, the Saudi embassy in Tehran had been ransacked, diplomatic ties between the two countries were severed and oil prices headed lower.
In the past, Middle East tensions led to gains in oil prices. Not this time. The prevailing wisdom is that the Saudi Arabia/Iran feud threatens to eliminate any hopes of an Opec agreement to cut production, at least in the near term risking further downside moves. The negative oil outlook has increased the downward pressure on the Canadian dollar.
Fed minutes and Fed speakers diverging
Wednesday’s release of the minutes from the December 15-16 Federal Open Market Committee (FOMC) meeting failed to provide insight into the timing of the next interest rate hike. The December interest rate statement noted that inflation remained below the 2% longer run objective blaming, part low oil prices and rising export costs. At the time, many observers classified the Fed actions as a doveish rate hike”.
Since then, the US has strengthened against the G-7 with the exception JPY. (EURUSD is almost unchanged) Notably, oil prices are lower than they were in December, albeit, marginally.
If oil prices move below support in the $32.00/b and spend the next few months probing for a new bottom, it would seriously damage the Feds hope for a rebound in inflation, as will a higher US dollar.
The FOMC minutes showed that some members expressed “significant concern about still low readings on actual inflation”. Also on Wednesday, Fed Vice Chair, Stanley Fisher said he though that four rate hikes in 2016 were “in the ballpark”. Just like in 2015, the Fed opinions are diverging or the Fed is dysfunctional. Although the market expects a 1% increase in US rates in 2016, the mixed messages emanating from the FOMC will ensure USDCAD volatility with a bullish bias.
Central Bank forecasts or hallucinations.
The Bank of Canada (BoC) governor, Stephen Poloz delivered a speech on Thursday that was either doveish or optimistic, flip a coin.
The doveish camp noted his concern that US rate increases would produce a downside risk to the BoC’s inflation forecast while harping about FX being a key adjustment tool for terms-of-trade shocks. That’s banker-speak for currency devaluation to boost trade.
The optimistic side stemmed from the conclusion that Mr. Poloz was not hinting at a rate cut this month, if at all.
The Bank of Canada may still be hallucinating. At this time last year, the BoC was telling all who would listen that the Canadian economy would rebound in H2. It did. Canada went from a “technical recession” in Q2 to tepid growth in Q3 and a weak Q4. But that’s ok because the economy will grow to a rate above potential in 2016.
Global forces drive Loonie
The domestic influences that normally impact the Canadian dollar have diminished greatly and were evident this morning. The Canadian employment report posted a 22,800 gain in jobs against expectations for a gain of 10,000. In fact, despite all the noise surrounding the monthly reports, Canada managed to squeeze out 151,000 full time jobs in 2015 which is notable due to the collapse of the energy market. Yet, FX traders didn’t care.
USDCAD is back probing the overnight high at 1.4140. Developments in China, the Middle East and US interest rate hike timing al have more sway over the Canadian dollar’s direction that domestic developments. And that is likely to be the case for the next few months.