The Impossible Trinity
- China is learning, the hard way, about the impossible trinity. You just cannot have free capital flows, a fixed exchange rate and independent monetary policy all at same time. The People’s Bank of China can either continue to run down its currency reserves or allow the yuan to float freely which would give back control of monetary policy to the central bank. A more yuan-friendly option perhaps is to temporarily impose capital controls, at least until investor confidence returns.
- With its inflation forecasts slated to be revised down yet again, the European Central Bank is poised to add stimulus at its March meeting, something that could weigh on the euro over the near term. The Bank of Japan, also struggling to hit its inflation target, took a page from the ECB’s book in January by pushing the deposit rate on excess cash balances held by financial institutions at the central bank into negative territory.
- Given the above, the USD is in a strong position to add to last year’s gains. But we remain hopeful the Fed will be as concerned as we are about the situation. Not only is a strengthening greenback hurting growth and keeping inflation low in the US, but it’s also raising risks of disorderly deleveraging in emerging markets considering the massive amount for USD-denominated debt in those economies. The threat of a global financial crisis and recession may be enough to convince the Fed to back down and tone down its tightening bias, something that could help take some steam out of the USD.
- We have lowered our forecasts for oil prices this year, expecting WTI to hit $40 by year-end ($50 previous forecast) and have accordingly downgraded our Canadian GDP growth forecast and C$ targets. Our call for USD/CAD to hit 1.36 by year-end hinges not only on rising oil prices but also on a large enough fiscal stimulus from the federal government which would negate the need for the Bank of Canada to cut interest rates.
Stéfane Marion/Krishen Rangasamy