Tuesday, June 2, 2009

Bank of Canada reversing course?

As recently discussed, the Bank of Canada has pledged to keep interest rates at 0.25% for about a year. I mentioned that they may be forced to raise rates if there was ever an attack on the loonie. This happened in 1992, I believe, and in 1998 during the Asian crisis.

Recently, the opposite has happened. The loonie is soaring and it hit 92 cents today. My portfolio is getting hit as my high cash position is mostly in USD (horrible timing to move to USD on my part), so take the following opinion as talking my book if you wish:

The recent move from 77 to 92, most of which has happened in the last month, has to be causing concern for the Bank of Canada.


1) We are in a deflationary period and a rising loonie is going to make things even worse, by making the inflation rate even more negative. Deflation makes real rates high (even with 0.25% nominal rates). This makes it difficult for interest rates to be stimulative.
2) The strong loonie is going to hurt our exports, which are already devastated by the recession. Certain commodities that are priced in US dollars will be just fine, but in places like Ontario, the manufacturing base (and GM?) can not be enjoying this recent rise in the loonie.
3) The timing of this currency appreciation is horrible, at a time when the window for the "green shoots" theory to work is open. Currency appreciation also works against the stimulus in the works.

Don't be surprised if the Bank of Canada, at its June 4th meeting, tries something to knock the loonie down.

At the last meeting in late April, the BoC annouced:

1) Interest rates were going to stay at 0.25% for over a year.
2) It would not be implementing quantitative easing (QE) for the time being.

Since then, 4 big things have happened:

1) The loonie has especially soared since BoC announced that there was nothing imminent on QE. Speculators used the annoucement and the loonie's position as a commodity currency to play the reflation trade.
2) Flaherty news of a bigger deficit last week (and the $10 billion of wasted money on GM yesterday) gives them cover (ie economy weaker than expected, deficits bigger than expected) to start QE.
3) Even the hawks at the ECB are trying QE.
4) Of late, interest rates are soaring. Left unchecked, it will kill the so-called recovery. QE will supposedly help.

Announcing immediate QE or that they are more inclined to do it (sooner rather than later) could take some of the recent gains out of the loonie and at least make it seem as if they are concerned about rising rates. They could also say that the recent rise in the loonie is not completely justified by economic fundamentals.

Don't get me wrong, I don't believe in QE and deep down, I am happy that the BoC said no in April. I also think that the loonie will ultimately trade based on market forces, regardless of what the BoC does. An announcement of QE though could trigger the inevitable correction in the loonie, however.

Is the Bank of Canada reversing course on QE? And perhaps later in 2009, will the market force it to reverse course on interest rates, thereby reversing both its announcements of the last meeting? 

Just asking...

Disclosure: Long USD cash and CAD cash. I think the loonie is topping here and heading lower in 2009, but I could remain wrong, and in the short run, anything is possible.


Toronto Real Estate said...

I still don't understand why Interest rates have to stay at 0.25% for over a year. That's a bit too long, isn't it?

Take care, Julie

Adil Burney said...

Barring a currency collapse or a pickup in inflation, I think that interest rates will likely stay at 0.25% for a long, long time. Why? We are definitely in a Great Recession at best, and quite possibly, a depression. I don't see a pickup in inflation despite the printing of money. A run on the loonie is always possible. Barring those two things, I think 0.25% is here for longer than BoC has committed to. Perhaps for a few years. Longer mortgage rates may creep up as supply concerns and government credit ratings deteriorate.

You must be a great real estate agent for actually reading such a bearish blog! Thanks

BBC said...

Will be be similar to Japan???

BBC said...

Will WE (not be) be similar to Japan...sorry!

Adil Burney said...

I fear Yes, although hopefully not as long (they are in Year 20 and counting). I see this dragging on for at least 3 to 5 more years and maybe longer if we continue to make policy mistakes....