Canadian Confusion

By: Brewer Futures Group | Fri, Apr 24, 2009
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Only two days after the Bank of Canada announced that the economy was contracting by 3% instead of the forecast of 1.2 % in January and after it cut rates to 25 basis points then promised to keep them there for a year, the BoC made no commitment on the use of quantitative easing to stimulate the Canadian economy.

Many investors had expected the quantitative easing to begin as early as today as recent reports over the past few weeks had indicated that the economy was weakening. Furthermore, the BoC may have baited traders into believing that some form of non-standard stimulus would be announced on April 23. Instead the BoC opted to take a wait-and-see attitude to allow monetary policy to take its course. It now seems that they want to see what effect the last rate cut will have on the economy before taking further action at its next meeting on June 4.

Canadian Dollar short sellers were caught by surprise following today's announcement as many had initiated positions in anticipation of quantitative easing. Much of the rally was attributed to short covering rather than new buying. The language of the announcement does not totally eliminate a financial stimulus plan but merely seeks to postpone it.

By allowing the last 25 basis point cut to work its way through the economy, some say the BoC probably made the right decision as it has had no experience in the risky business of quantitative easing which is basically the printing of money. If the BoC overshoots its target then serious inflation problems could arise.

The BoC says it is now willing to wait until June 4 to allow the economy to show signs of recovery. If the economy worsens by then, look for the BoC to get aggressive. The USD CAD is likely to trade sideways-to-lower until the June date but losses may be limited to the downside because there are no indications that a bottom in the Canadian economy has formed yet.

The problem with the BoC plan is there is no plan. Their hesitation in providing stimulus to the economy could backfire like it has for the European Central Bank when they hesitated in cutting interest rates. It should have followed the lead of the United States and the United Kingdom, both of which have cut rates and applied quantitative. This delay in stimulus could prove to trigger more serious economic problems within the next month.

The Euro rallied on Thursday following the release of a better than forecast Index of European Services and Manufacturing Report. This news triggered a strong short-covering rally while sending a signal to the European Central Bank that an interest rate cut to below 1% may not be necessary. The recent weakness in the Euro had been triggered by uncertainty regarding whether interest rates would fall below the 1.0% level. Today's news seems to clarify things.

The reaction by traders today came as a surprise because the economic report indicated more weakness but traders decided to find something optimistic in it by noticing that the rate of the decline was less than the previous month. The bottom line is that this was still a bad report which means the Euro Zone economy is likely to continue to weaken.

Some want to believe that the economic slump is easing but I hesitate to reach this conclusion until I can see an uptrend by key economic indicators developing especially in housing, employment and production.

News that Credit Suisse posted better than expected earnings supported the Swiss Franc most of the day. The up move was most likely short-covering as investors still believe the Swiss National Bank wants to see a weaker currency while deflation threatens the economy.

A comment by Swiss National Bank Chairman Hildebrand may have inadvertently triggered a Swiss Franc rally recently. Hildebrand said "Before we look at steps like negative interest rates, you have to have patience to let the medicine work." Some traders interpreted this comment as pro-interest rate cuts while diluting his comment late last week of possible intervention.

The comment may have been taken out of context. His statement was directly related to a question about interest rates and should not have been interpreted as an abandonment of intervention techniques to combat deflation.

The real mission of the SNB at this time is to fight inflation and keep pressure on Swiss Franc appreciation in an effort to encourage demand for Swiss exports. At this time the SNB stands poised to act in any way possible to accomplish this goal. Look to buy a dip in the USD CHF if given the opportunity.

The British Pound rallied on Thursday following the previous day's budget deficit related weakness. Today's rally was probably related to short-covering and profit-taking as it seems most unlikely that investors would express happiness with the increase in debt announced today and another increase in income taxes.

I am still questioning the decision to raise taxes for top earners. This decision could backfire since it will take more money out of the hands of consumer spenders and put it in the hands of the government. This can't be good for the economy especially if retail sales continue to drop.

News of improved credit markets helped support both the AUD USD and NZD USD. Bullish investors are hoping the thawing of the credit markets will help support the Aussie and Kiwi.

Today there were some signs of increased trader appetite for risk. This helped to support the Aussie throughout the day. Gains could be limited however as the Australian economy is still in a deepening recession which may require additional stimulus action by the Reserve Bank of Australia to help pull it out of the mud.

Greater demand for higher yielding, higher risk assets helped to support a higher close for the NZD USD. This rally is likely to be short-lived as the New Zealand economy is still in question. Traders are now beginning to price in a 50 basis point cut in the country's benchmark rate.

The Reserve Bank of New Zealand is already on record opposing the use of interest rates at current levels. It believes that interest rate changes take too long to work their way through the economy. This is why investors should not only watch for a cut in interest rates by the RBNZ but also quantitative easing or a message-sending intervention.

 


 

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