Market Watch: Canadian Dollar

Is it time for the Canadian Dollar to make a significant correction against its Australian counterpart?

The Canadian dollar is traditionally one of the more difficult currencies to predict in terms of medium to longer term movement, given direction is principally dictated by a number of factors outside the confines of the Canadian economy and the monetary policy moves of the Bank of Canada, namely 1) the general trend in global commodity prices and 2) close affiliation and thus link to the performance of the US economy and the US dollar.

It is thus a risky currency to trade, although over the past 12 months it has generally traded within a fairly confined range against the US dollar, while trading a little stronger against the Euro for all of 2013. The Canadian dollar has not had anything like the same inflated gains achieved by the Aussie and New Zealand dollars since the turnaround in global financial markets, but this is thanks to the much more accommodative interest policy adopted by the Bank of Canada, as against that adopted by the Central Banks in Australia and New Zealand. Interest rates in Canada have remained at 1.00% while the higher rates on offer in the Aussie dollar (3% + up until recently) meant that any speculative holding trade involving commodity currencies has generally gone on the Aussie dollar. The recent sharp fall in metal prices and the reduction in overnight rates (to 2.75%) announced by the Reserve Bank of Australia last week has triggered some dilution in this holding trade, and the loonie is now up 5% against the Aussie in the past month. However, the pair are due a further correction given the Aussie is still trading almost 30% higher against the loonie than when the pair last traded at a fully corrected price back in early 2009. Of course the problem with being bearish on the AUD/CAD pair is the punitive overnight cost of the interest rate differential (2.75% Vs 1.00%), but the signs do indicate this pair should make a significant move downwards, certainly down to 95 and possibly down to 90, through the course of this year.

But, and this is an important but, the Canadian dollar will only make significant gains against the Aussie on the back of a move downwards in AUD/USD, and thus a good hedge to take on in tandem with a sell of AUD/CAD, is to sell USD/CAD. While not the perfect hedge, it will significantly reduce the risk of holding AUD/CAD in the medium term, while the interest rate differential in selling USD/CAD is in the traders favour (0.25% Vs 1.00%). This strategy is for an initial 3 months.

Ted - May 15 2013

Austerity and ECB Policy

Last Thursday the ECB announced a 25 basis points reduction in its overnight rate bringing interest rates to 0.50%, the lowest level they have reached in the Euro era. An accommodative policy has been adopted by the Federal Reserve, ECB, Bank of England since the Financial crisis in 2007-2008, but all the evidence suggests this policy has failed miserably to stimulate many of the major economies in the developed world, with contraction again the dominant force in Europe and Japan, while the US experiences a moderate recovery. The Euro area economy contracted at an annualised rate of 0.6% in the final quarter of 2012, while Japan contracted at a rate of 0.4%. The UK economy grew by a slight 0.6% annualised rate in the first quarter of 2013, while the US economy expanded by a more impressive 2.5% in the same quarter.

Little to none of the cheap money being fed into the bank chain from the top of the hierarchy by the Central Banks is making its way into the real economy - i.e. by way of retail bank support and lending to small businesses and end consumers. If the people that are the lifeblood of the economy are starved of cash and disposable income, then the real economy is missing the basic stimulus it needs to grow and the Central Banks need to reassess its policy, or, more importantly, reassess how the institutional banks are interpreting their policy. Owing to flagrant indifference of the banking sector to the Central Bank's policy intentions, any trickle of funding that does currently make its way from the banks to the real economy usually brings with it a vastly inflated interest rate tag, just to reinforce the fact that accommodative monetary policy is not accommodative where it is needed. None of this money is available at an affordable price where it is needed most.

But if the cheap money being ushered out by the Central Banks is not going into the real economy, where is it going?

Answer: Into risk assets such as commodities, bonds, even equities. How? The institutional banks are borrowing cheap money from the Central Banks, such as the Fed, ECB and Bank of Japan, and rather than making this money available for end borrowers (the original intention of the Central Banks), the Institutional banks are diverting the cheap funds from the Central Banks into their own investment channels, to speculate on higher risk investments in the hope of a more profitable and quick return. For the most part this tactic has worked over the last 3 years with largely exaggerated price increases achieved in commodities and equities, while sovereign bonds in many defunct European countries are now achieving close to record yields for investors. The added political lobbying by bank interests of influential governments within the European Union has helped to safeguard bond investments, as the EU currently prohibits sovereign debt write-downs and the burning of major bondholders exposed to Europe's burgeoning sovereign and banking debt. Any country that might consider straying from this policy is threatened with expulsion from the Euro.

For the institutional banks it is a no-brainer. Why lend money to the man on the street or to someone starting up in business, with the risk that entails, when the option exists to direct this money into a 6% yielding bond, a speculative fund investing in oil futures (up 50% since 2009), or gold (still up 113% in the past 4.5 years despite a recent sell-off) or equities (The Dow is up a massive 130% in the same period). A 5-year term loan given to a small business might yield 18% over 5 years and is not without risk, while a mortgage given to an end consumer might yield 40% after 20 years. The differential gap in terms of potential yield between investment risk and lending risk is something of a moral dilemma for institutional banks, but not one they lose any sleep about, and when push comes to shove it is lending to the real economy that is losing out to speculative investment. Of course what this means is that with cheap and free money barging its way into riskier assets, these assets have grown at a rate which is completely out of synch with growth in the underlying economies and thus the aforementioned assets are completely overpriced in real economic price terms and the run-up in prices is unsustainable, and many of these assets are soon headed for a serious downward correction, if not crash landing, in the not too distant future. Oddly enough, given the impact of political bullying and potential ECB intervention, sovereign bonds within the Euro area may be at the lower end of this risk investment scale.

So what does this mean? Central Banks are accelerating a policy of providing cheap money to banks so these banks may use this money to invest in risk instruments rather than lend this money to the real economy. The net result for many of the underlying economies is economic contraction as government austerity measures intensify and fuel costs continue to inflate, thanks largely to the speculative investment which the Central Banks are inadvertently helping to fuel. Cash-starved businesses in developed economies are being run aground and unemployment in Europe is now at a Euro era high at 12.1%. Japan's Central Bank is currently undertaking desperate measures to try to discredit it own currency with the result that the currency has fallen 28% against the dollar in the past 8 months, while the Nikkei has soared 63% since the middle of November. The price moves in Japan are totally at odds with the economy's lack of economic growth and its underlying fundamentals and the price moves appear more fictional than real. It just does not seem plausible that such moves can occur and be representative of the economic facts. But of course they are not representative of the real economy, rather they are representative of the repatriation of cheap funds originating from the speculative children (banks) of accommodative Central Bank policy, as their fund managers race trigger-happy across the globe, in an avaricious chase for big profits from risky assets.

Why are institutional banks allowed to borrow money for half nothing from the ECB, Bank of England, Bank of Japan and the Fed, when this cheap money is not finding its way into the real economy and is not being used to help the economies of the Euro, UK, Japan and United States? The reason is simply because, despite the near-collapse of the banking sector in Europe just a frighteningly short time ago, the ECB and other major Central Banks have failed miserably to impose the proper regulatory procedures required to keep the money distribution policies of banks under control. It is incredulous that the ECB itself has not imposed stricter rules and monitoring procedures, for tracking cheap funds being poured into the banking sector, given the strict rules it has imposed on the Governments of the Euro area, forcing an era of severe and heretofore unseen levels of austerity, for most of the citizens of the Euro area. Is it that the ECB, and Central Banks generally, are run by bankers whose modus operandi is for the benefit and growth of banks, moreover the real economy and its citizens?

Bob - 7th May 2013

The Dollar, Bernanke and the Golden Goose - Are they Coming Home to Roost?

It is interesting to note the top three headlines on CNBC business news this evening:

‘Why are Investors so Worried about a Stronger US Dollar’

‘Fed will Keep Rates near Zero through 2010’ says Bill Gross

and

‘Rates to Remain Low’ says Ben Bernanke

Why is it that such mundane speak is making headlines all of a sudden (apologies to our other Bob on the floor)? Well it’s like this: last Friday the dollar had its only significant one-day rally in 6 months and early on Monday the unthinkable happened, i.e. the dollar sustained a rally into a second day, something that has been rather unheard of since last March. This has put the frighteners on many institutional investors, most of whom have made large profits on the back of a weak dollar, and basically on nothing else. If your reason for financial living begins to be questioned or it is beginning to wear thin, you look to your usual suspects - financial leaders like Ben Bernanke and Bill Gross to reaffirm your (albeit fundamentally flawed) strategy and have them undermine the counter view. This is exactly what has happened today although in Gross’ case he was merely putting his own spin on what Bernanke himself had just said. Why rein in the wisdom and direction of a herd when the good shepherd is on your side?

And why the sudden need to pull the rug from under the dollar? The reason is simple – Friday’s jobs report reveals that in November the US shed the lowest number of jobs it has lost in any month since the recession started 2 years ago. The marginal 11k loss caught most analysts by surprise, with even the most conservative data watchers having predicted a job loss of at least 100k. To compound matters, the number of jobs lost in October was revised downwards by a further 80K, thus the jobs report across the 2 months was far less negative than nearly everyone had anticipated.

So why is such positive news proving worrisome for US investors? Why is 'not so bad' news bad for stocks and commodities (Gold fell almost $50 an ounce last Friday). Surely in a year where there has been zero to cheer about down on Main Street some little bit of respite in the labor market would be taken positively by markets, markets that are meant to represent these same economic facts and prospects? The problem of course is that financial markets do not represent economic facts, not currently in any event. There is a massive disconnect between main street and Wall Street, something that has only widened dramatically this year, despite major assurances from Messrs Bernanke and Company following the financial market collapse last year. In just six 'primarily recessionary' months Ben Bernanke and his cohorts have managed to fuel an asset bubble in stocks and commodities which in normal boom times would take 8-10 years to build. By bending over backwards and sideways, and somersaulting over the Chinese and other US debt holders, Bernanke has pumped enough ‘money for nothing’ into the system to trigger a 60% plus rally in US stocks between March and November and to infuse sufficient panic about the US ‘well being’ that investors have flooded into all forms of anti-US wellbeing financial instruments like gold, oil, every other dollar denominated commodity known to mankind and every single currency that is not a US dollar or a US dollar proxy (such as the Yuan). The resultant depletion of the value of US denominated assets relative to other currencies is quite staggering in the context of it only taking 6 months to get there. Loose fiscal policy from the US Administration and almost limitless free money from the Fed has enabled unrepentant investment banks and other greed-driven financial institutions to say thanks by creating an enormous bubble in financial markets, the likes of which has never been seen before.


The much publicized recovery we hear about every day on CNBC and Bloomberg is another one of those recoveries that is unfortunately divorced from economic reality (we love Maria Bartiroma but pretty please they need to change those other records). Hedge fund managers are falling over themselves (many on the airwaves) to try and justify their reckless trades and investments and thus the lauding of them folk Bernanke and Gross, who always seem to serve the interests of financial markets in those high gloss towers over the economic coalface down on Main Street (well, at least Bill has a colourful reason, albeit a selfish one, but our Ben was supposed to have read the black and white pictures in those 1930s annuals). If Ben or anyone looks at the latest Commitment of Traders Report on gold, we find that there is currently almost $28 billion of speculative long positions on gold (all managed funds) against only $860 million of short positions. This means a staggering 97% of speculative trades are betting that gold is going to continue to rise in value against 3% that believe it will fall – it hit $1226 an ounce last week. Such biased positions are not sustainable in the long run. They never are. Gold is very close in bias terms to where oil was in July last year before it crashed. Other notable extremes exist for many other related instruments including silver, the Aussie dollar and the Swiss franc. Trichet used to warn of such investment extremes before but even he has gone to pasture on this one, although he is the most consistent vocal on the needs for a stronger dollar, whatever that means. Tim Geithner's vocal interventions for a stronger dollar are laughable efforts and usually tend to lead to the dollar being sold off more sharply. US policy on the dollar is kinder garden stuff and when we hear officials advocate a strong dollar it usually can be translated as meaning 'a weak dollar please, but not so weak today as it might be please - (tomorrow).'

In a market where we have instruments with anything from a 2:1 to a 30:1 bias against the US dollar, it does not require sound economic reasons for market players to buy the dollar to initiate market chaos and to force a meltdown of asset prices. It simply requires a reality check on the part of those over-zealous investors (currently the majority) and to see an inevitable move on their part to the exit stalls. When a huge Stadium becomes overcrowded panic can set in more readily and a stampede could ensue, without warning. Bernanke and the world’s governing body (Central Bankers) have once again failed to patrol this particular Stadium and their general ignorance to events and their total inability to learn any lesson from what happened just 12 months ago means that the next fatal episode will lie at the door of their layer of command. They are the upper hierarchy of the global banking system, and they will be responsible for the next bubble-bust and financial crash, soon to be visited upon us, barring a miracle. Let us just hope this particular goose does not turn out to be a Bernanke roast that ends up on our table this Christmas.

We may need Bill Gross to give up the day job and work them airwaves again to keep Ben's goose at bay (mind you, it must be tough to have to manage the world's largest bond fund during a time of great economic distress, yet have all the time in the world to talk on TV). Way to go, Bill.

Bob B - Dec 7, 2009