By Michael O’Neill

“Are central bankers yo yo’s, is that the way you do it?

They are printing money like they’ve gone crazy

Hardly anyone is working, that’s why they’re doing it

Money for nothing, and your rent is free”

Global economies are in dire straits.  The coronavirus pandemic has crushed 2020 global growth forecasts.  On April 1, Fitch Ratings predicted negative 1.9% global GDP, compared to consensus forecasts of 3.4% at the start of the year.  No one should be surprised that COVID-19 decimated the global economic growth outlook after a third of the world’s population was placed in some form of lock-down.  Over 100 countries closed national borders, supply chains snapped, while tourism, and air travel virtually disappeared.

A close up of a map

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Source: UN Department of Economic Affairs

Something had to be done, and the G-10 Finance Ministers and Central Bank Governors rose to the challenge.  On March 3, they held a conference call, and issued a communique saying “G7 finance ministers are ready to take actions, including fiscal measures where appropriate, to aid in the response to the virus and support the economy during this phase. G7 central banks will continue to fulfill their mandates, thus supporting price stability and economic growth while maintaining the resilience of the financial system.”

That was also the day government fiscal restraint died.

The Fed was first of the mark, with a surprise 0.50% rate cut, March 3, although they didn’t sound convinced of the need for the move. They said “the fundamentals of the U.S. economy remain strong.  However, the coronavirus poses evolving risks to economic activity.” Any reluctance to cut rates evaporated on March 15, with the spreading pandemic. The Fed slashed the fed funds rate by 1.0%, taking the range to 0.00-0.25%.  They turned on the liquidity fountain as well, by adding $1.5 trillion to the banking system through reverse repo operations, started a $700 billion quantitative easing (QE) program, announced a Money Market Mutual Fund Liquidity Facility, and latter topping up repo operations with another $500 billion

The US administration got into the act, spending 11.0% of GDP (per statista) for a variety of stimulus programs.

The US actions were followed by rate cut and stimulus announcements from the Bank of England, Reserve Bank of Australia, and Reserve Bank of New Zealand.  The European Central Bank delivered a new $750 billion QE program but to date, a coordinated European Union stimulus package is still the subject of debate.

The Bank of Canada drank the “G-7 coordinated stimulus” Kool-aid.  They cut interest rates three time in March, taking the overnight rate from 1.75% to 0.25%.  Governor Stephen Poloz took a page out former Fed Chair Ben Bernanke’s book and introduced a Canadian version of quantitative easing.  Esteemed economist Ted Carmichael, of TC Global Macro said of the BoC’s QE program ” It took 85 years for the BoC to grow its’ balance sheet to $120 billion. It has taken just two weeks to expand it to $215 billion.

Graph: BoC and Fed balance sheet growth

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Source: TC Global Macro

The multi-trillion dollar question is whether these economic cures will be worse than the virus.

It wasn’t that long ago that countries strived for a budget surplus or at least a balanced budget.  Former Conservative Prime Minister Stephen Harper’s government recorded a $1.5 billion surplus in the 2014-15 fiscal year, after six years of deficit spending thanks to the 2008 financial crisis.  Prime Minister Justin Trudeau’s Liberal government turned that surplus into a $225 billion deficit as of this week.  Mr Trudeau famously said that “budgets balance themselves.” His great, great grandkids are hoping he will be right, as they are the ones that will be paying for today’s government excesses.  Simply put, balanced budgets may be essential for individuals and households as the alternative is living on the street.  

However, for governments, especially in a zero rate/low rate environment, why worry?  Government spending supports domestic growth, job creation, and by default, increased government revenues through higher taxes.  Free-spending politicians get re-elected with funding promises to many vocal special interest groups.  In the most recent election in Canada, some conservative retirees with minimal pension benefits, gravitated towards the NDP, because they supported higher social security benefits.  If interest rates stay low, incumbent governments will not be interested in alienating voters with fiscal austerity.

Canada is not alone with budget drama.  The coordinated G-7 coronavirus response made sure of that. 

Just as a rising tide lifts all boats, bloated budget deficits, balance currency deficiencies.  The Canadian dollar differentiates from the rest of the major G-10 currencies because of its status as a pseudo-petro-currency.  Since January, USDCAD moves closely correlate with WTI oil prices.  When WTI oil bottomed out at $20.10/barrel, on March 18, USDCAD peaked at 1.4655. The relationship is far from perfect as USDCAD dropped to 1.3947 on April 7, even as WTI retreated from its overnight peak of $27.22 to $24.35/b. 

The key driver of USDCAD price action is broad US dollar sentiment against the majors, but oil price action determines whether the currency pair out-performs or lags its G-10 peers.

The global economy may be in dire straits, but the mountain of “money for nothing” may keep the domestic market in tune, for now.