At some point Sunday night, the champions of Super Bowl 50 will be crowned. Whether it is the Denver Broncos or the Carolina Panthers, Americans will refer to the winner as “World Champions”. That conclusion is a testament to their arrogance, considering that of the 510.1 million square miles of surface on the earth, the USA represents a mere 2% and their version of Football isn’t even played anywhere else on the planet.
However, their arrogance is warranted when it refers to the impact that US fiscal, economic and monetary policies have over the global economy. Federal Open Market Committee (FOMC) decisions have a ripple effect right around the globe and their effects were readily apparent this week.
For almost all of the past year, financial markets had a singular focus and that was when or if the Federal Reserve would put an end to the zero interest policy (ZIRP). The FOMC answered the bell on December 16 and raised the federal funds rate to ¼ to ½ percent. At that time, they rationalized the move because of their “economic outlook and recognizing the time it takes for policy actions to affect future outcomes”. In the “Summary of Economic Projections, the committee projected the Fed Funds rate to be 1.4% for 2016, which represent four ¼ point increases throughout the year. The US dollar rallied.
When daylight dawned on the brand new trading year for 2016, traders awoke to news of another equity market collapse in China. That set the tone for the entire month. Global equity markets sank, oil prices tanked and there was a shift into risk aversion trades.
The January 27 FOMC statement gave a nod to the global turmoil and markets reacted by paring back the number of interest rates hikes for 2016. In the first week of February, two voting members of the FOMC, Vice Chair Stanley Fischer and New York Fed president William Dudley created a firestorm. Mr. Fischer expressed concern that the global market turmoil could undermine the US economy and two days later Mr. Dudley said that global markets had tightened since the December rate hike. Those four rate hike forecasts back in December; they disappeared.
Not surprisingly, the US dollar collapsed. The Canadian dollar recovered its entire January losses and then some. It is currently sitting about ½% higher then it was at the beginning of the year. Even stranger, the Japanese yen gained over 3.3% against the US dollar and is the best performing G-10 currency, year to date. And that is despite announcing a negative interest rate policy on January 29. EURUSD has also rallied over 3% year-to date and European Central Bank president Mario Draghi is promising a sequel to the stimulus package announced in December.
Of the big three central banks, the Bank of Japan (BoJ) and the European Central Bank (ECB) are actively cutting interest rates and attempting to jump start their economies. The US Federal Reserve is raising rates. In that environment, selling US dollars just doesn’t make sense.
Fed Chair Janet Yellen testifies before the Senate Financial Services Committee on February 10th and she may provide some clarity on the rate hike debate. If her remarks are even in the least bit ‘hawkish”, the US dollar will rebound. Watch for additional US rate hikes getting baked back into forecasts.
There are other reasons to expect the US dollar to rebound. The US interest rate debate is similar to the debate that raged last October. Fed board members, Daniel Tarullo and Lael Brainard made very doveish statements leading to fears of a “split FOMC” with rate hikes on hold. The US dollar tanked, but we know how that story ended.
Friday’s US nonfarm payrolls report went a long way in dispelling the notion that that global economic turmoil was threatening the health of the US economy. The unemployment rate is in in” full-employment” territory at 4.9% and wages have risen 2.5%, year over year.
The Canadian dollar has been caught up in these events but has two additional elements that have had a major impact on the currency; oil prices and the Bank of Canada (BoC).
The downward pressure on WTI is expected to continue until there is some evidence that the current over-production issue is dealt with. This week, there were many reports that Venezuela was attempting to broker enough support for an emergency Opec meeting and even had Russia on-board. However, until Saudi Arabia sits at the table, the chances for any meaningful production cuts are slim. Barring supply disruptions from unforeseen events, that should limit WTI gains and by default Canadian dollar gains as well.
The Bank of Canada is on the sidelines. They are unlikely to provide any monetary policy stimulus until the federal budget is tabled (which may not be until April) and the details of the promised fiscal stimulus package are revealed. Mr. Poloz admitted that when the BoC governing council met on January 20, he thought that they would be cutting rates implying that had Justin Trudeau not promised massive infrastructure spending, Canadian rates would be ¼ point lower.
The US dollar was in need of a correction and we finally got it. The “long dollar” trade was the most popular trade in 2015 and was more crowded then a subway at rush-hour. Arguably, the aggressive sell-off this week was the capitulation of stubborn long term bulls bailing out of their positions.
The major economies of the world are employing or contemplating employing, negative interest rates and various other measure to help jump start their economies. Meanwhile, the US economy is humming along, maybe not on all cylinders but on enough of them to warrant raising rates.
The Canadian economy is sputtering, job growth is tepid and the jobs that are created appear to be skewed toward self-employment. For the time being, USDCAD will continue to track oil price movements and there is little evidence that the over-supply issue has been corrected. In fact, new Iranian production will make it worse.
The USDCAD decline from 1.4688 to 1.3635 or about 7% in less than two weeks was impressive. Nevertheless, despite the magnitude of the drop, USDCAD remained well above the 100 day and 200 day moving averages. The long term USDCAD uptrend from July 2014 remains intact while trading above 1.3300.
The US dollar decline over the past several days turned intraday technicals bearish and attracted dollar sellers, in part due to diminished rate hike expectations. They may be sorry. The US dollar is down but it is far from out.
David Marks ,Analyst Agility Forex.
