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Yen and the Art of Market Disappointment

by Karl Schamotta | July 29, 2016

Global currency markets are in recovery mode this morning, with many traders reacting with disbelief to the news that the Bank of Japan plans to keep interest rates and asset purchases at the levels established over the past few months. In ruling out ‘helicopter money’ drops into the economy, Governor Kuroda firmly handed the baton to Shinzo Abe and triggered a massive surge in the yen – capping a volatile month in which monetary easing expectations have caused it to whipsaw across an increasing wide trading range.

The central bank’s unconventional monetary policy measures have lost efficacy even as they have grown in scale over the past fifteen years, and domestic financial conditions have become increasingly distorted suggesting that traders and investors will have to turn to the government itself for additional stimulus in the future. Without Kuroda diluting its value, the currency seems headed on a kamikaze mission toward the 100 mark.

Here on the northern side of the 49th, the loonie is trading on a slightly weaker bias after Statistics Canada reported that the economy caught fire in May – and not in a good way. Activity contracted by the most since early 2009, with the Fort McMurray wildfires singeing a significant swathe of the country’s goods-producing sector. While we have been fairly bearish on the Canadian economy over the past year, we don’t expect this effect to remain intact for long – if history is any indication, the stimulative effect of disaster recovery efforts should combine with the continued explosion in homebuilding to lift activity in the June and July reports. Winter is coming, but it hasn’t come yet…

The pound sterling continues to carry the tarnish picked up during last month’s referendum, trading within an unusually tight range ahead of next week’s Bank of England. Mark Carney and his merry band are expected to cut interest rates for the first time since 2009, and may widen the bank’s quantitative easing programme by an additional 50 billion pounds in an attempt to stall the economy’s decline. Over the past few weeks, high-profile firms like Barclays and British Airways have lined up to issue increasingly dire forecasts about the aftershocks yet to hit, while sentiment indicators have deteriorated steadily.

In contrast, the dollar continues to march higher. After this week’s deceptively mild rate announcement from the Federal Reserve, traders are girding themselves for a rate hike at one of the next three meetings scheduled for this autumn. Market-based probabilities are more heavily weighted toward a December move than path dependencies would otherwise suggest, with many investors apparently betting that uncertainty around the US Presidential election will keep the central bank sidelined until after November.

While this is an intuitively compelling narrative, the historical record would suggest that the Fed’s commitment to independence is much more deeply rooted than the casual observer might believe. Presidents from Nixon to the first Bush have complained about rate hikes landing during election years, and we can find no instance where political determinations have overtly swayed policymaking.

Slack in the American economy has steadily dissipated over the past three years, and wage pressures are beginning to rise. Should this trend be confirmed over the coming month (particularly when a pivotal non-farm payrolls report is released at the tail end of next week), there’s little to stop the Federal Open Market Committee from moving ahead with a rate hike in September or October.

Either way, it would be wise to remember John Templeton’s timeless warning, “the four most expensive words in the English language are ‘This time is different'”.

Have a great weekend!

Karl Schamotta

Head, Enterprise Risk

@vsualst

 

Counterparties:

Reading to accompany your Monday margaritas;

Bloomberg: Three Things That Show Investors Are Making a Huge Bet on Low Interest Rates

Bloomberg: Economists Really Are Better Than Markets at Telling You How the Economy Is Doing

Telegraph: IMF Admits Disastrous Love Affair with Euro

Reuters: Pioneer Says Some U.S. Fracking Costs Competitive with Saudis

Strategy+Business: US Manufacturing is Thriving

Project Syndicate: Explaining Persistent Low Interest Rates

Xinhua: Report Says 7.51% of China’s Industrial Businesses are “Zombies”

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