By Michael O’Neill
Rocketman and USDCAD are “getting high as a kite.” One from illicit pharmaceuticals and the other from global trade pessimism. Trade worries were on full display in the Bank of Canada’s (BoC) monetary policy statement, released May 29.
It didn’t start out that way. They left rates unchanged and the statement started out rather positively. Policymakers “humble-bragged” about their forecasting prowess, taking more than a little pride saying that “recent Canadian economic data are in line with the projections in the Bank’s April Monetary Policy Report (MPR), with accumulating evidence that the slowdown in late 2018 and early 2019 is being followed by a pickup starting in the second quarter.” The back-patting continued.
They noted “Continued strong job growth suggests that businesses see the weakness in the past two quarters as temporary. Recent data support a pickup in both consumer spending and exports in the second quarter, and it appears that overall growth in business investment has firmed.”
If they had stopped at paragraph three, USDCAD would have traded lower. They didn’t. They continued with “The global economy is also evolving largely as expected since April, although the recent escalation of trade conflicts is heightening uncertainty about economic prospects. In addition, trade restrictions introduced by China are having direct effects on Canadian exports.”
That sentence strapped the rocket under USDCAD, sending it soaring to 1.3544 from 1.3486, in a flash, and breaking a critical technical resistance level in the process.
The BoC’s concern about the impact of Chinese trade restrictions on Canada suggests Canadian rates are on hold until the US/China trade dispute is resolved. All indications are that both sides have dug in for the long haul.
US claims that China reneged on a draft agreement that had evolved over ten months of discussions were disputed by China this week. Not officially, but via an editorial in a state-controlled newspaper. China blamed the Americans for constantly changing their demands. China also balked at demands for a “completely open internet,” demands to boost imports by $100 billion/year and the Americans role in how currency manipulation is determined.
Tensions were already elevated after the US blacklisted Huawei Technologies, banning US companies from doing business with the Chinese company, without a license. Secretary of State Mike Pompeo was rather blunt in his assessment of the risk Huawei posed. He described it to FOX Network saying “Huawei is an instrument of the Chinese government. They’re deeply connected. It’s something that’s hard for Americans to understand.” Huawei filed a motion in a US district court in Texas, asking for part of the National Defence Authorization act to be overturned. It doesn’t look good.
China is hinting at a major retaliation. Rare earth elements are vital components for such things as cell phones, computers, batteries of all kinds, air pollution control and most electronic devices, among other things. China is the source of 80% of all US imports of these metals, which gives them some much need leverage. China could impose quotas, or levy export surcharges, or even ban exports. That risk has unsettled global financial markets.
Global equity indices were noticeably spooked. Month-to-date, Hong Kong’s Hang Seng index plunged 8.29%, and China’s Shanghai Shenzhen CSI 300 dropped 6.37%. Japan’s Nikkei fell 5.64%, and the major European were all down around the same amount. The Nasdaq was the worst performing major US index with a monthly loss as of May 29 of 7.31%.
Trade tension jitters and falling equity markets fueled demand for the traditional safe-haven currencies, the Japanese yen and Swiss franc. There were other influences at work, as well. UK Prime Minister Theresa May’s resignation, European Parliamentary elections, and an escalation of Iran/US tensions kept the US dollar in demand.
The BoC policy statement put topside pressure on the USDCAD range of 1.3370-1.3520, which contained price action since March. The post-statement rally broke the top, but the follow-through was not impressive. Nevertheless, it may just be a matter of time. The BoC stated concerns about external trade issues suggests Canadian rates aren’t going anywhere, until the US/China trade war is over, and assuming a new one with the European Union hasn’t started.
The trade war has taken a toll on the bullish oil price outlook. Traders are starting to believe that a prolonged trade war elevates the risk of a deeper global economic slowdown, which more than offsets support from Opec supply cuts. They voted with their wallets. West Texas Intermediate prices dropped from an April peak of $66.65/barrel to $56.91/b on May 29. There could be more weakness ahead as a sustained breach of $57.30/b targets $54.50/b, which would underpin USDCAD in the process.
The Canadian dollar economic outlook has improved remarkably from the beginning of the year. The icing on the cake is the repeal of US steel and aluminum tariffs. Unfortunately, a long list of negatives has overshadowed the benefits. They include falling oil prices, rising trade tensions, slowing global growth, as well as risk aversion sentiment from UK politics and Brexit.
USDCAD, like Rocketman has reached lift-off.