Major CAD News This Week: March 6, 2012

Last week we were treated to a very active currency market! The long-term financing operation (LTRO) conducted last Wednesday by the European Central Bank, combined with higher than anticipated growth in the U.S. GDP, gave new life to our dollar. To the great pleasure of greenback buyers, our loonie took flight and finally broke out of a narrow trading channel. On Friday, the U.S. dollar ended the week down over 150 basis points, its lowest level in six months. The value of the euro slid over 250 basis points against the U.S. dollar. A currency devaluation is to be expected when a central bank prints money to inject liquidity into its economy. Given that several central banks are meeting this week and employment data are slated to be released, the market risks to be highly volatile once again.

Canada
The week in Canadian news begins on Tuesday with the Ivey Purchasing Managers’ Index. On Thursday, Housing Starts data will be released and we will also have the Bank of Canada’s interest rate decision. Because analysts are expecting the rate to be unchanged at 1%, currency markets players will be pouring through the press release that follows this announcement, trying to anticipate the next rate movement. The week will end with the release of employment data on Friday. Economists believe that the unemployment rate will be unchanged from the last reading, i.e. 7.6%.

United States
The week in the U.S. will be just as newsworthy. We begin on Monday with the ISM Non-Manufacturing Index for the month of February. On Wednesday we are expecting ADP Employment Change data on private sector employment. This figure is sure to provide an indication of the Unemployment Rate, to be released on Friday. With initial jobless claims at their lowest level since April 2008, it will be interesting to see whether the unemployment rate  will reflect this improvement. At this stage, analysts are expecting this indicator to come in at 8.3%, or unchanged from the last reading.

International
A busy week is expected in international news. On Monday, we will have eurozone Retail Sales figures for January. On Tuesday, the Bank of Australia will be the first central bank out of the gate with its key interest rate decision. Also on Tuesday, we will know the eurozone’s GDP for the fourth quarter of 2011. It is expected at -0.3%. On Wednesday, the focus will be on the ECB’s announcement of its key interest rate. It will be interesting to see which action Mario Draghi will take one week after holding the Bank’s second LTRO. After only 4 months at the helm of the BCE, Mr. Draghi appears to have already developed a reputation for unconventional approaches. Still on Wednesday, Japan will release GDP data for the fourth quarter of 2011. On Thursday, Australia will release its unemployment rate and the Bank of England will announce its rate decision and the amount of its bond purchasing program. The week will end with the release of inflation data in China and Germany. Have a nice week!

The Loonie

The U.S. Federal Reserve, like all central banks, must carry out its monetary policy from the perspective that the impact of its actions will only be felt in the economy several months later. This is much like a cruise ship taking several minutes to change direction or a few kilometres to come to a complete stop. In the heat of the financial crisis, in order to avoid hitting the iceberg, the Fed not only lowered interest rates but also acted directly on the markets, buying U.S. bonds on the secondary market. Through quantitative easing, the Fed printed notes to change the ship’s direction faster.

The Fed’s semi-annual report, released last week, made no mention of quantitative easing, which is in itself a significant signal. The central bank believes that the way has been sufficiently cleared for the market to carry on without making any additional direct interventions; while the iceberg may still be there, we fear it less. The graph below shows two important variables for the U.S. economy. Wholesale trade, in red, is synonymous with production and indicates future retail sales and economic activity. The graph shows an increase in activity over the last few months, particularly in transportation, and businesses are clearly rebuilding inventories. In fact, sales have surpassed pre-crisis levels.

The blue line is the employment curve, or the source of consumer income, the key driver for the economy as a whole. While employment is clearly trailing wholesale trade, this is perfectly normal: businesses wait until excess capacity has been eliminated before they hire new staff. But the graph also shows how employment has been slowly recovering over the last few years, and that trend is accelerating. In fact, the blue curve should follow the red curve, and this should continue for some time to come. On the Fed’s watch, the gigantic U.S. cruise ship now appears to be heading in the right direction, and this is good news for the Canadian economy.

Technical Analysis: Breaking Out of the Triangle

USD/CAD: Last week the Canadian dollar rose a great deal against the greenback. As seen in the graph below, the USD/CAD pair was caught in a triangle (in red), limited below by the most recent increases in the Canadian dollar (0.9890 and 0.9900) and bounded above by the peaks of the last few months (1.0400, 1.0300 and 1.0050). The loonie therefore started the month of March with a bang, breaking out of this triangle and gaining almost 150 points in three days. Even if indicators such as the RSI suggest an highly overbought range (on CAD purchases), perhaps suggesting an imminent rebound, the USD/CAD rate is clearly below its short and long-term moving averages. This trend can only be changed by a break through the highest resistance level, at 1.0051. In the short term, this movement will allow the USD/CAD to test the 0.9840 and 0.9802 levels. It remains to be seen whether the relative calm in international markets will continue long enough for the Canadian dollar to take full advantage of this breakout.

Fixed Income

Long term rates remained fairly stable for the week, as the market sentiment improved and investors continued to show interest for riskier assets.

The rally we’ve seen in the recent weeks was prompted by encouraging macroeconomic data, combined with cheap cash from monetary authorities, including last week’s liquidity offerings from the European Central Bank (ECB).

The bank allotted €529.5 billion to 800 financial institutions last week, an amount higher than at its first so-called LTRO operation last December, which lifted Canadian yields from their historical lows.

On the macro front, Statistics Canada said last Friday Canada’s economy slowed during Q4 of 2011, but the performance was still stronger than expected, keeping investors confident.

Many kids are off for the school break this week, but most investors should keep themselves busy as we expect the next trading sessions to be especially volatile:

Thursday, the Central Banks of England, Europe and Canada all meet to announce their interest rates. The BoC is expected to remain on hold, but the news release should include hints for the future that could impact the curve. Friday, job creations for the US and Canada will be released and analysts expect increases of 220,000 and 15,000 respectively for each country.

Commodities

The European embargo on Iranian oil appears to have made the energy market vulnerable. Prices rose quickly on Thursday, following the announcement of a pipeline explosion in Saudi Arabia, highlighting the level of fear in the market. During the day, the prices of Light Sweet Crude (WTI) and North Sea Brent peaked at $110.55 and $128.40 per barrel, respectively. While the Saudi government denied that there had been an explosion, the panic underscores the limited global excess production capacity. According to data from the International Energy Agency (IEA), 72% of OPEC’s excess capacity is found in Saudi Arabia. From an economic point of view, rising oil prices may become the main cause of concern for a global economic recovery. Notably, Barack Obama recently said that he would like to avoid a preventive military attack on Iran. The U.S. will hold presidential elections on November 6, 2012, and an oil shock would leave the incumbent vulnerable.

Last Week at a Glance

Canada – Canadian GDP growth moderated to 1.8% annualized in the final quarter of last year, in line with the consensus expectation. However, the third quarter was revised up sharply from 3.5% to 4.2% annualized. As expected, trade was a contributor in Q4 – exports grew at 4.6% while imports grew at only 2.1%. Domestic demand rose at 2.1% in Q4, an improvement from the tepid Q3 showing. It was driven by consumer spending, up a healthy 2.9% annualized on the strength of spending on durables and services after a soft Q3. Business investment in machinery and equipment grew at 2.7% after a steep decline in Q3. Residential construction grew at 3.3%. Inventories subtracted from GDP for a second straight quarter (−1% annualized). The Q4 report showed an expected cooling of growth from Q3, but the upward revision to Q3 and an excellent December reading made it better than expected. For 2011 as a whole, Canada’s GDP expanded 2.5% compared to 1.7% for the United States.

The current account, Canada’s broadest measure of trade, showed a $10.3-billion deficit in Q4, an improvement from $12.3 billion in Q3. The improvement was largely in the merchandise trade account, whose surplus rose to $3.1 billion from $248 million. The services trade deficit widened to $6.2 billion and the investment-income deficit rose more than $0.5 billion to $6 billion. For the year as a whole the current-account deficit was $48.3 billion, a $2.5-billion improvement from 2010.

United States – Durable goods orders fell 4% in January, the largest monthly decline since January 2009 and much worse than the consensus expectation of a 1% drop. Non-defence aircraft orders shrank 19% on the month. As a result, transportation orders fell 6.1%, with improved orders of vehicles and parts easily offset by Boeing's weak order book. Ex transportation, durable goods orders were not as bad but not good, down 3.2%. Non-defence capital goods orders excluding aircraft, a signal of future investment spending, fell 4.5%. Total shipments of durable goods were up 0.4% overall but down 1.1% ex transportation. Shipments of non-defence capital goods ex aircraft were down 3.1%, suggesting a softening of business investment in the first quarter.

The unambiguous weakness of the durable goods orders report ends a run of consensus-topping U.S. numbers. The expiry of incentives such as the accelerated capital depreciation allowance was probably a factor in the cooling of investment, as was the cloud of uncertainty that still hangs over the global economy. The latest Conference Board survey shows consumer confidence continuing to improve. From 61.5 in January, the index rose to 70.8 in February, the highest in 12 months. Consumers were more upbeat about both their current situation and the outlook. Asked about jobs, they answered "hard to get" in fewer numbers than in many months (index of 38.7). Eagerness to buy autos was also up from January. Fourth-quarter real GDP growth, initially estimated at 2.8% annualized, was revised up to 3.0%, with larger contributions from consumption and residential construction and slightly smaller drags from nonresidential structures, trade and government relative to the initial estimate. The contribution of inventories was a bit less than initially estimated, which meant that final sales ended up rising 1.1% annualized in Q4. Growth in domestic demand was also 1.1%, two ticks better than in the initial estimate. Q4 was the best U.S. quarter of 2011, thanks to inventory accumulation. So growth is likely to moderate in Q1.

Personal income grew 0.3% in January and spending 0.2%. The savings rate fell one tick to 4.6%. In real terms, spending was flat for the third consecutive month. Real disposable income fell 0.1% after a 0.3% increase in December. The core PCE deflator, preferred by the Fed over the CPI as a gauge of inflationary pressure, rose 0.2% on the month, keeping the 12-month rate unchanged at 1.9% (the previous month was also revised up one tick). The ISM manufacturing index fell to 52.4 in February from 54.1, the first drop in five months. Its new orders component fell to 54.9 from 57.6. The production index fell marginally to 55.3 and the employment index fell a full point to 53.2 (though both components are still well into expansionary territory). The sub-index for new export orders soared to 59.5, the highest since April 2011, suggesting that global demand is still in decent shape. The ISM reading is consistent with the Beige Book's observations that U.S. manufacturing output continued to ramp up in February. Fed chairman Ben Bernanke gave no indication that further expansion of the Fed balance sheet is on the way. Instead he chose to start his testimony before Congress by stating that the U.S. economy continues to recover and that the available information suggests growth in coming quarters at close to or above the 2.25% pace of the second half of last year. Still, Mr. Bernanke noted that with no substantial declines in the unemployment rate expected this year and the inflation outlook still subdued, FOMC participants expect that they will be justified in keeping the fed funds rate extremely low into late 2014.