Any move above par is unlikely to be sustained for a long period of time, as domestic fundamentals should eventually adjust to external realities. Much of the support to Canada’s economy has come from the public sector and from domestic credit expansion, both of which cannot continue to grow indefinitely. Trade balance numbers will be watched very carefully in the coming months.

Crude oil prices slipped marginally ahead of this week’s OPEC meeting.Production changes are not expected, but the ministers present are expected to call for greater compliance with current production quotas. Base metals continued their recent declines as traders contemplated the potential impact of policy tightening in China. Nickel dropped 1.7%, copper was down 1.5%, and aluminum slid 1%.

Federal Reserve is Wild Card for the Week

The Federal Open Market Committee meets tomorrow, and the markets generally expect few changes to existing policy. That being said, there is an outside possibility of an increase in dissent among members, and the Committee may also choose to drop the commitment to keep interest rates low for an “extended period.” If this were to occur, a rally in the USD would follow shortly thereafter. Volatility is to be expected prior to the announcement at 2:15 Eastern time on Tuesday.

According to rumours widely reported on Friday, President Obama is expected to name Janet Yellen as the next Federal Reserve vice chairwoman. Currently chair of the San Francisco Fed, Yellen is known as one of the Fed's most outspoken doves, and supports keeping interest rates low for a prolonged period of time in order to support economic and employment growth. This appointment is expected to swing the balance of power slightly against those who wish to tighten policy quickly, and may have a negative effect on the US dollar in the short term as traders downgrade the possibility of tightening in the next few months.

Rest of the Pacific More Pacific

In Japan, Prime Minister Yukio Hatoyama said that the yen had become too strong relative to the strength of the economy, outpacing the recovery. Addressing criticism from opposition lawmakers, he said that the Japanese government needed “to take firm measures against such a type of strong yen.” He also made comments on the global currency markets, stating that “some sort of global political co-ordination is also necessary” to address imbalances and adjust currency values towards more palatable levels. After an initial flurry of activity, the yen quickly slipped back into recent trading ranges as markets discounted the possibility of immediate intervention by the Bank of Japan.

The Aussie and Kiwi currencies lost recent gains as markets shifted into a less-than-optimistic mood to start the week. The economies of both countries are heavily tilted towards growth, and interest rates will come under pressure in the event that global growth slows. Benchmark interest rates sit at 4 percent in Australia and 2.5 in New Zealand. The Reserve Bank of Australia is widely expected to raise rates further at the next meeting in May, but the hikes should lose momentum shortly afterward.

Greek Tragedy Turns Less Dramatic

The Euro broke a three-day rally against the dollar after the French and German finance ministers both ruled out making decisions on financial aid for Greece in the next few days. Greek authorities have not yet made a formal request for aid, and are attempting to manage the situation independently. Ministers from across the currency zone and from the wider EU are meeting today to discuss possible intervention measures in the event that the austerity programme fails.

As the threat of outright debt default by the Greek government recedes, the Euro seems to be gaining a degree of stability. Traders have slowed their betting on a sovereign collapse and have shifted focus towards relative growth rates between Europe and the United States. A move back towards 1.45 against the dollar seems likely, but the currency’s longer-term prospects will be hampered by lower economic growth and continued fiscal distress among the smaller member countries.

Relations Worsen Between US and China Over Currency

The war of words between China and the West heated up over the weekend as Premier Wen issued a sharp rebuttal to critics of China's fixed exchange rate regime. "The Chinese currency is not undervalued” he said; "We oppose all countries engaging in mutual finger-pointing or taking strong measures to force other nations to appreciate their currencies." He likened Western pressure to protectionism, saying: "What I don't understand is depreciating one's own currency, and attempting to pressure others to appreciate, for the purpose of increasing exports. In my view, that is protectionism." Senator Charles Grassley responded by saying that “Chinese officials are alone in their refusal to acknowledge that the yuan is undervalued. If they choose to stick their heads in the sand, we’ll have to find another way to address this problem because it’s been going on for far too long.”

Recent negotiations between the two countries have been fraught with difficulty. Wen and Obama are finding their political options dwindling, as a mutual failure to trade political capital has increased domestic pressures. Any efforts at compromise would result in a loss of face for both leaders. Speculation is rising that the US Treasury will label China a “currency manipulator” in its next exchange rate report, adding fuel to the protectionist fires already burning in Washington. Without conciliatory efforts at the leadership level, these tensions will continue to grow, causing disruption in the financial markets.

Have a great week!

Karl Schamotta