Emergency Retreat
The retreat from emergency ultra-low interest rate environments, QE, and other monetary easing concoctions has been signaled by various central banks over the last couple of weeks. The race towards normalising monetary policy is now on. The immediate implications of this new meme are that bond yields are moving higher and the USD is weakening against other currencies whose central banks have signalled a shift in policy.
The US Federal Reserve is clearly the leader in this movement with four rate rises in 18 months. Be that as it may, ironically, it is the lone central bank about whose future moves Mr. Market is most skeptical. The USD’s recent weakness suggests that investors currently have more faith in the retreat from monetary easing of global central banks than that the Fed will add more rate rises this year. Having said that, the beleaguered USD enjoyed a respite from the selling pressure after Friday’s mixed US labour market report was good enough to solidify expectations that the Fed is still on track to continue normalizing its monetary stance. Also worth noting, the Fed’s policy meeting minutes this week suggested it may also soon begin paring back its large bond holdings in the coming months.
As one would expect, the currencies whose central banks are reluctant to signal a policy shift will be sold off – as was the case for the AUD and JPY. The Reserve Bank of Australia left its cash interest rates at 1.5% and the language of its announcement truly neutral on Tuesday causing the Aussie to drop. The RBA said the Australian economy is expected to strengthen gradually, but said consumption growth remains subdued linked to slow growth in real wages and high levels of household debt.
Meanwhile, all this hawkish talk from other central banks forced the Bank of Japan to calm markets. The BOJ offered to buy an unlimited amount of Japanese government bonds on Friday, as it sought to put a lid on domestic interest rates being pushed higher by the hawkish rhetoric of other central banks. The aggressive move sent most JGB yields lower and weakened the yen. The move marked a reversal in the recent slow and stealth tapering of the bond buying operation central to the BOJ’s easy monetary policy and reminded Mr. Market that the BOJ is not in this newfound hawkish central bank camp.
The next central bank that looks ready to join the hawkish camp is the Bank of Canada. The CAD has been on a tear since the beginning of May, up around 6%, after its two leading policymakers stressed the end of monetary easing is near. The BOC is widely expected to hike interest rates at this Wednesday’s policy meeting for the first time since 2010. If there was any doubt, Friday’s robust Canadian jobs report cemented the BOC’s rate hike expectations. Job growth has been sizzling, lifting the 12-month gain to 350K, of which, a solid two-thirds have been full-time positions. Furthermore, for the past three-quarters, the economy has grown around 3.5% and appears off to a solid start in Q2. Canada's trade balance has also improved, helped by a recovery in non-energy exports. It is easily the fastest-growing economy in the G7.
The near-term fate of the CAD will depend on the accompanying language of the interest rate announcement. If there is any indication in the statement that another rate increase is going to come fairly quickly then the CAD will be poised for more gains. However, if the BOC suggests a wait and see attitude then the CAD will retrace some of its recent gains.
If the BOC does raise rates twice this year it will be a mirror reflection of its moves in 2015 – when it cut interest rate twice to support the economy after the brutal drop in oil prices. Interestingly, with the price of oil at $44, it is below the levels at which the Bank of Canada last cut interest rates in January and July of 2015. Thus, with the economy on firm footing now, the BOC may indeed be ready to take back the two emergency rate cuts of 2015.
Two hikes can easily send the CAD to the 80 cent level. However, for now, the momentum indicators are getting a little stretched and they may be set to turn with Wednesday’s policy announcement. If you need to sell the CAD then a better opportunity may arise after Wednesday
Key Data Releases This Week
Forecast | Previous | |||
MONDAY, JULY 10 | ||||
TUESDAY, JULY 11 | ||||
WEDNESDAY, JULY 12 | ||||
04:30 | GBP | Average Earnings Index 3m/y | 1.8% | 2.1% |
10:00 | CAD | BOC Monetary Policy Report | ||
10:00 | CAD | BOC Rate Statement | ||
10:00 | CAD | Overnight Rate | 0.75% | 0.50% |
10:00 | USD | Fed Chair Yellen Testifies | -2.5M | |
10:30 | USD | Crude Oil Inventories | -6.3M | |
11:15 | CAD | BOC Press Conference | ||
THURSDAY, JULY 13 | ||||
08:30 | USD | PPI m/m | 0.0% | 0.0% |
08:30 | USD | Unemployment Claims | 244K | 248K |
10:00 | USD | Fed Chair Yellen Testifies | ||
FRIDAY, JULY 14 | ||||
08:30 | USD | CPI m/m | 0.1% | -0.1% |
08:30 | USD | Core CPI m/m | 0.2% | 0.1% |
08:30 | USD | Core Retail Sales m/m | 0.2% | -0.3% |
08:30 | USD | Retail Sales m/m | 0.2% | -0.3% |
by TONY VALENTE Senior FX Dealer, Global Treasury Solutions |