Forex Update: March 27, 2012

To the delight of anyone selling the greenback, last Thursday and Friday were quite eventful and the U.S. dollar rose strongly against the loonie, briefly testing levels seen approximately two weeks ago. This strength was supported by the release of worse-than-expected Purchasing Managers’ data from China and various euro zone countries. Another factor that held back the Canadian dollar against the greenback was Canadian retail sales results, which were a major disappointment for the market.

A busy week awaits, in terms of data and speeches that may well influence currency markets.

Canada

It will be slim pickings in Canadian news this week. On Thursday, we will all be paying attention as Jim Flaherty presents the 2012 Federal Budget. This event, which traditionally triggers a strong reaction in Canadian citizens, will certainly affect the fiscal policies established by Mr. Carney and the Bank of Canada. The Canadian news that stands to have the greatest impact on the loonie will surely be the release of GDP numbers for the month of January. It is expected at 1.7%, or 0.1% below the last reading.

United States

Regarding news, a heavy slate is expected in the U.S. this week. Various members of the Fed, including Mr. Bernanke, will be giving speeches at different times of the week. Some do not share the majority view at the Federal Reserve, so we will listen intently for the information supporting their views of the economic situation in the U.S., as well as globally.

Starting on Wednesday, each of the expected indicators has the potential to influence currency prices. Durable Goods Orders for the month of February will be released; analysts expect the number to be 6.9% higher than one month earlier. On Thursday we will have the latest GDP figure, and on Friday we can expect figures on Personal Spending and the Michigan Consumer Sentiment Index.

International

Following the release of disappointing Purchasing Managers’ data for the euro zone last week, the market will be paying close attention to all figures from Europe and China. The week begins on Monday with the German Ifo Business Climate Index. On Wednesday, we will have the German Consumer Price Index; on Thursday, the German unemployment rate; and on Friday, German Retail Sales for February. The week, international news ends on Friday with the Consumer Price Index for the euro zone and a meeting of European leaders on how to increase their bailout fund.

The Loonie

The decision to hedge exposure to exchange rates always depends on several factors. Some are internal factors, such as decision makers’ appetite for risk, while others are external, such as the strength of the businesses with which you conduct business abroad.

According to a J. P. Morgan survey conducted in early March, during the last six years there have been changes in the currency hedging behaviour of exporters and importers. In North America and Europe, they found that the hedging percentage has declined since 2006, while in Japan specifically, it has increased. The reasons mentioned in the survey for this new trend include the risk posed by Europe and the risk of sustained growth for major powers and the emerging markets.

This certainly gives food for thought. What about your hedging ratio? Has your hedging strategy changed over the last six years? Did the extreme fluctuations experienced in 2008 and 2009 change your approach? The Canadian dollar has been relatively stable since mid-2010, considering approximately a +5% and -5% from parity movements. These movements can have a considerable impact on your bottom line.

The Canadian economy appears to have gathered steam over the last few months. Now that the economy is picking up in the U.S., rumours abound that the Fed might increase their interest rate sooner than previously thought. Will the Bank of Canada dare raise its key interest rate earlier than expected? This would surely put wind in the loonie’s sails, to the detriment of the Canadian economy, which is largely export-based.

USD/CAD

USD sellers enjoyed the rebound last week but should remain cautious, given that the important levels haven’t budged. Here is a brief summary of the situation:

The 4-month trend (the green line) has finally been broken through; Indicators such as the MACD show bullish divergences (lower on the USD/CAD, unconfirmed by lower points on indicator).

However, the 200-day moving average and the 1.0050-1.0070 range still contain increases Friday saw a loss of upward momentum (doji, the red arrow).

Prudent USD sellers will leave orders between 1.0000 and 1.0050. The most optimistic among them will anticipate a breakthrough around 1.0050 and leave orders in the 1.0130-1.0200 range. Any close under 0.9838 would send a negative message (return to 0.9750).

For USD buyers, the market is still on your side, but caution is called for if it breaks through 1.0070.

Fixed Income

Fixed income markets remained relatively stable last week, as investors held on to their breath and waited for the latest reactions to the recent steepening of the yield curve.

Market euphoria vanished and rates stabilized on Tuesday, even losing a few basis points, as new concerns emerged that economic growth will slow in China.

On Friday, as expected, Statistics Canada announced Canadian inflation had accelerated last month. Price increases reached their fastest pace in more than three years on higher electricity and meat costs for Canadian households.

Rates later closed the week slightly down compared to the previous.

For the week ahead, we will watch for the release of the Teranet-NBC monthly housing composite on\ Wednesday, as well as GDP numbers from the US and Canada, respectively Thursday and Friday morning.

Commodities

Energy prices rose strongly Friday on rumours of a drop in Iranian exports. There is considerable concern in the markets, and the imposition of a European embargo should eventually drive down exports. This represents a real problem for many countries that must now find new sources of supply. Meanwhile, the Executive Director of the International Energy Agency (IEA) has said that there is no need to tap strategic reserves to curb rising gasoline prices.

The situation is quite different in the natural gas market, where inventories are very high and prices are down 24% since the beginning of the year. On March 16, inventories were 54% above the five-year average.

Last Week at a Glance

Canada

In February, the all-items consumer price index was 2.6% higher than 12 months earlier. In January, the year-over-year change in the CPI was 2.5%. Core CPI accelerated as well, reaching 2.3%, two ticks above the previous month’s reading. Month over month, headline CPI was up 0.4% for the second time in a row. Core prices jumped 0.4% after rising 0.2% the month before. On a seasonally adjusted basis, the monthly increases were tamer, with headline CPI up 0.1% and core prices 0.2% higher.

All eight major components were up on the month (s.a.) with the exception of shelter (-0.2%). Clothing and footwear (+0.8%) and transportation (+0.5%) registered the strongest advances. Four provinces saw their 12-month inflation rate pick up. The largest increases were observed in Ontario (from 2.4% to 2.9%) and Quebec (from 2.8% to 3.2%). At the opposite end, the sharpest declines were registered in Alberta (from 2.9% to 1.9%) and New Brunswick (from 3.2% to 2.6%).

Energy prices accounted for a large portion of the inflation surge, but they were not the only reason CPI is presently growing at above trend pace. In fact, prices in 5 of the 8 main categories are currently outrunning their respective long-term averages. As for the BoC’s preferred measure of inflation, the level struck in February was its highest since December 2008. Back then, the global economy had already slipped into recession and disinflation was in the cards. Today, both core goods and core services are hovering above the midpoint of the central bank’s inflation target range and the economy is still expanding.

In our view, this development suggests spare capacity in the Canadian economy is waning. Still, for the time being, the inflation numbers remain roughly in line with the BoC’s latest forecast.

In January, retail sales rose 0.5%, well short of the 1.8% increase consensus had anticipated. As expected, autos were the driver of gains, with a 3.7% advance. Excluding these, however, sales flagged 0.5% (versus consensus expectations for a 0.5% upturn). Gains in clothing and health/personal care were more than offset by retreats in other categories, including electronics (-3.4%) and building materials (-5.2%).

Thanks to autos, sales of discretionary items (i.e., total retail sales excluding groceries, health/personal care products, and gasoline) progressed 0.8%. Gasoline’s share of total retail sales sank a touch to 12.4%. In real terms, sales climbed 0.3%, extending their positive streak to six months. Though the retail report disappointed consensus, Canadian consumers still got off to a decent start in 2012. After swelling 0.3%, retail volumes are tracking at a healthy 2.2% annualized rate in 2012Q1.

The gain in retail volumes should somewhat offset weakness in real manufacturing and a 1% contraction in wholesale trade. Wholesale trade’s second decline in three months was driven mostly by a 3% drop in autos. However, weakness was generalized, with six of the seven broad subsectors receding. In real terms, wholesale trade slid 1%. This combined with the drag from manufacturing reported earlier points to lacklustre GDP growth for January.

In a separate report, however, Canada’s "leading" indicator (LI) sprang 0.6% in February for an eighth increase running. This raises hope for decent economic growth for Canada in Q1. Our forecast is for GDP to grow at an annualized rate of about 2%.

United States

In February, housing starts fell 1.1% to 698K from an upwardly revised 706K the previous month. Singles drove the decline with a decrease of nearly 10%, which practically nullified the gains of the two prior months. Multiples provided some counterweight by springing 21% after the previous month's 13% increase. The month-over-month drop in starts is not alarming given that they were still up 34.7% year over year. What’s more, building permits vaulted to 717K, their highest mark since October 2008.

In a separate report, existing-home sales pulled back 0.9% in February. However, the prior month’s figure was revised up from +4.3% to +5.7%. As a result, February's tally of 4.59 million unit sales (seasonally adjusted at an annual rate) translated into a 12-month increase of 8.8%, roughly in line with consensus expectations.

Initial jobless claims for the week of March 17 fell to 348K from an upwardly revised 353K. These were the lowest initial claims since March 2008. The more reliable 4-week moving average dipped 1K to 355K. Continuing claims dropped to 3.35 million, their lowest level since August 2008. The multi-year low for U.S. jobless claims is encouraging, particularly as it came in the reference week for non-farm payrolls.

Euro Area

Euro zone data surprised on the downside. In March, the Manufacturing PMI fell to a 3-month low of 47.7. Perhaps the biggest surprise was the double dip in Germany’s PMI, which sagged to 48.1, its lowest point since last November when the European sovereign debt crisis was in full swing.

According to Markit Economics, new orders declined at an even sharper rate than output did, resulting in a ninth straight monthly drop in work backlogs. This will likely put further downward pressure on German factory output in April. Moreover the composite index, which accounts for manufacturing and services, ebbed to 48.7. This performance was all the more disappointing in that it follows a month that saw unusual weather conditions paralyze much of Europe.

The Danube froze over for the first time in over a generation and business activity was severely hindered. The fact that the euro zone continued to shrink in March speaks volumes about the underlying weakness of the region. We are sticking to the view that things will probably get worse in Europe before they get better. Our current forecast is for the euro zone economy to contract 1.5% this year, versus consensus expectations for a 0.3% pullback.

China

The factory data that came out of China was not very encouraging, either. According to HSBC’s flash estimate, the PMI fell to 48.1 in February, its lowest level in four months. The details of the report showed a drop in new orders, employment and backlogs. Both domestic and foreign demand bore down on growth in March. The weak Chinese data comes at a time when copper inventories are already at an all-time high and aluminum inventories are plump in Shanghai. Softer prices seem warranted for these commodities going forward.