CAD Outperforming
08/03/10 22:29
UBS and other banks economists expect a June rate
hike by the Fed of 25bp. That puts our Fed rate hike
forecast ahead of much forecasted July BoC rate hike
by approximately one month. However, it may be useful
to examine a period in which the monetary policies of
the Fed and the BoC have diverged in the event that
BoC decides to hike earlier or by more than 25bps
initially, given the BoC's hawkishness, or our Fed
rate hike spec gets pushed back.
The US was in recession from March 2001 to November 2001. Canada, however, did not go into recession during that period as it did not suffer relatively as much from the after effects of the burst tech bubble and the 2001 terrorist attacks. Through January 2002, the BoC had cut 375 bp to 2.00% while the Fed had cut the fed funds by 475 bp to 1.75%. In April 2002, the BoC commenced a tightening cycle independent of the Fed based on stronger than expected economic growth. The BoC noted that there was still substantial monetary stimulus in place and eventually hiked its policy rate to 3.25% by April 2003 and kept it there through mid-July 2003. From April 2002 to mid-July 2003, however, the Fed cut the Fed funds rate another 75bps to 1.00%. When the spread between the BoC and Fed policy rates widened during that period, the CAD appreciated against the USD by approximately 13%.
The US was in recession from March 2001 to November 2001. Canada, however, did not go into recession during that period as it did not suffer relatively as much from the after effects of the burst tech bubble and the 2001 terrorist attacks. Through January 2002, the BoC had cut 375 bp to 2.00% while the Fed had cut the fed funds by 475 bp to 1.75%. In April 2002, the BoC commenced a tightening cycle independent of the Fed based on stronger than expected economic growth. The BoC noted that there was still substantial monetary stimulus in place and eventually hiked its policy rate to 3.25% by April 2003 and kept it there through mid-July 2003. From April 2002 to mid-July 2003, however, the Fed cut the Fed funds rate another 75bps to 1.00%. When the spread between the BoC and Fed policy rates widened during that period, the CAD appreciated against the USD by approximately 13%.
The period discussed above has some parallels to the current period: unlike the US, Canada did not have a banking or housing crisis. In addition, the BoC did not have employ quantitative easing. However, in the current situation, even though the BoC could hike its policy rate before the Fed, an important difference is we do not expect that the Fed would be cutting its policy rate at the same time. The Fed, would likely be on hold. As a result, CAD could strengthen against the USD in that scenario, but not by as much or likely for such an extended period. As a result, we would consider being long CAD against a non-USD cross, especially against a currency in which the respective central bank is lagging behind in the policy normalization process, into the key BoC dates. Thus, we like being short EURCAD or short GBPCAD. We also continue to watch for an opportunity to short AUDCAD. However, a pause by the RBA ahead will largely be data dependent and this week's Australian employment figures will be key.
Several Eurozone officials commented on the proposed European Monetary Fund and central bank exit strategies. ECB President Trichet said not to interpret removal of non-standard measures as a signal for an imminent policy rate increase, though he did note that global growth is relatively robust and sentiment is better now. Meanwhile, the ECB's Stark said that any proposed European Monetary Fund would be against EMU rules and that a rescue fund would undermine public acceptance of both the Eurozone and the euro. He also said that unsolved sovereign fiscal problems could exacerbate the financial crisis. German Chancellor Merkel said the idea of a European Monetary Fund was interesting and reiterated that there is no aid for Greece at present.
Source: UBS, Bloomberg, Chris Lori