Friday, January 15, 2016

On Loony Markets and Loonie Forecasts?

CNBC reports, Dow futures briefly plunge 400 after data; 10-yr yield dips below 2%:
U.S. stock futures indicated a sharply lower open on Friday after disappointing U.S. data and the Chinese stock market and crude prices plunged.

Dow futures briefly fell more than 400 points after retail sales declined 0.1 percent in December. Ex-autos, retail sales also fell 0.1 percent. The Producer Price Index fell 0.2 percent in December after rising 0.3 percent in November.

January Empire manufacturing was minus 19.4.

Treasury yields fell, with the 10-year yield dipping below 2 percent and the 2-year yield near 0.83 percent. The U.S. dollar index traded about 0.4 percent lower, with the euro at $1.09 and the yen at 116.81 yen against the greenback, as of 8:37 a.m. ET.

The Shanghai composite fell 3.51 percent and entered bear market territory, while Brent and WTI futures both held below $30 a barrel, down about 5 percent each. The pan-European STOXX 600 index fell nearly 2 percent.

The blue chips index was also dragged down by falls in Intel, Apple and Goldman Sachs. Intel reported better-than-expected earnings Thursday, but the stock is down about 6 percent in the premarket on Friday.

Traders also looked to a speech from New York Federal Reserve President William Dudley.
I just finished writing a comment on the brutally cold chill of deflation, going over why I thought RBS's call to "sell everything" was ridiculous as these markets are overreacting to bad news out of China and a looming deflationary crisis which is coming but not here yet.

Then I wake up on Friday to see oil prices hit fresh multi-year lows amid fears of what effect Iran flooding the market with crude will have on the commodity and this rattled markets.

Unfortunately, the decline in the price of oil is not only a supply story but also a demand story and that's reflected in weak consumer spending numbers. All these economists and strategists wondering why U.S. consumers aren't spending their "windfall gains from the energy tax cut" obviously don't get it.

Importantly, the dynamics of debt deflation are such that people petrified of losing their job are hunkering down, saving more and frantically trying to pay off their mounting debt bills. And that's not going to change because the price of gas is falling. All they will do is use that extra money to save more and pay off their debts. And don't forget, a lot of baby boomers are looking to retire with little to no savings as stocks head south, which will add more pressure on the U.S. savings rate.

What else? The great U.S. economic recovery isn't as great as people think. I discussed why last Friday in my comment on minding the wage gap. The reality is wages are stagnating and the sell-off in the stock market doesn't portend well for employment growth in the second half of the year (just check out Wal Mart's big announcement this morning).

This is why I disagree with my former colleague, Brian Romanchuck, who thinks the Fed should ignore the stock market. The Fed can't ignore the stock market and more importantly, it can't ignore the bond market, which is clearly worried that deflation is spreading and the Fed is making things worse.

To be fair, Brian clarified his comment on Twitter in a response to my comment (click on image):

I don't know how this will all play out but as I stated in my previous comment on the brutally cold chill of deflation, this sell-off can easily become self-fulfilling and if it does, expect central banks around the world, including the Fed which made a huge mistake raising rates in December, to come out shortly with a massive coordinated response to help calm jittery markets.

I still maintain that things are way too pessimistic and my reading of the volatility (fear) VIX indicator (VXX) tell me that it's time to buy the dip (click on image):

Interestingly, this morning, New York Federal Reserve President William Dudley said this in a prepared speech: "With respect to the risks to the inflation outlook, the most concerning is the possibility that inflation expectations become unanchored to the downside." 

He then addressed questions where he said negative rates are a potential tool, but not under consideration at the Fed right now.

Negative interest rates, eh? You don't say? We know all about those here in Canada where things are going from bad to terrible despite what our Prime Minister and Finance Minister are publicly stating.

In fact, a day after the loonie slipped below the 70-cent US level for the first time since 2003, a forecaster at investment bank Macquarie says he expects the loonie to lose another 10 cents to reach an all-time low of 59 cents by the end of 2016:
David Doyle of Macquarie Capital Markets Canada Ltd. lowered his Canadian dollar forecast to 59 cents US on Tuesday. That would eclipse the all-time low for the loonie, set on Jan. 21, 2002, at 61.79 cents US.

Doyle knows of what he speaks. Last February, when the Canadian dollar was valued at just over 80 cents, he — correctly, as it turns out — predicted the loonie would hit 69 cents US at some point in the next 12 months.

It did so Tuesday.

"Once [the loonie] reaches this level," Doyle said, "it should remain subdued through [the end of] 2018 and potentially even longer."

Doyle's new forecast doesn't see the loonie above 65 cents US at any time between the end of 2016 and the two years that follow.

The loonie has been whipsawed of late by oil and the U.S. dollar. Oil prices can't find a bottom, with a barrel of the North America crude oil benchmark dipping below $30 a barrel for the first time in 13 years on Tuesday. That's dragging the loonie down with it, as Canada's dollar is widely considered to be a play on oil prices.

But strength in the U.S. dollar is making the loonie look even worse.

Economic uncertainty makes investors flock to assets perceived as safe, and for the most part none are perceived to be safer than the U.S. dollar. That drives up the greenback's value. So while the Canadian dollar is sliding lower compared to most currencies, it looks especially cheap compared to the U.S. buck.

Doyle's bleak outlook for Canada doesn't stop at the loonie, however.

Rate cut coming?

The Bank of Canada is set to reveal its latest interest rate decision next week, and Doyle is among a strong minority of analysts who expect a cut to 0.25 per cent from its current level of 0.5. But he goes even further, saying another cut bring the central bank's lending rate to zero per cent some time this year is "a possibility."

"The rapid weakness in [the loonie] means that Canada should experience comparably elevated inflationary pressures relative to the United States over the next 12 months," Doyle said.

David Madani, from Capital Economics, also expects the Bank of Canada to cut its key rate by a quarter of a percentage point next week.

In a Wednesday commentary, he said new data suggests that the Canadian economy contracted in the final quarter of last year.

"Not only this, the further plunge in commodity prices — led by oil — over the past month or so has completely undermined prospects for economic growth this year," he said.

TD chief economist Beata Caranci makes much the same argument in a Wednesday report, saying "a case exists" for a rate cut on Jan. 20.

"However, if the Bank [of Canada] decides to stand pat to observe the degree to which recent economic weakness is transitory in nature, the focus will turn to the forecasts within the [monetary policy report], and a rate cut down the road remains entirely plausible," she writes.

Mixed blessing

In the past, a cheap dollar was a mixed blessing for the Canadian economy: a boon for exporters, but bad news for importers and Canadians who need to travel or spend money outside the country.

But the gains to be had from a cheap dollar often take a while to show up. The pain, on the other hand, is almost immediate.

As Bank of Montreal economist Doug Porter asked in a note on Tuesday, "What does it mean for the economy?"

"Consumers benefit, a tad, from the drop in energy prices, but are no doubt hurt by the dollar's slide. And, the blaring headlines about a sub-70 cent dollar are likely to [hit] confidence further," he said.
I sent this article to a buddy of mine who trades currencies and he shared these thoughts with me:
"And what has been their accuracy.... it's always great these guys come out when we have already moved 40% or more and come out with headline seeking forecasts. I am not even going to read it, but it probably coincides with oil at 15 USD, negative interest rates and the threat of a housing bubble bursting... it's the end of the world... Yes, if all those happen then the currency will weaken, but at some point the weak currency will translate to Ontario and Quebec driving growth after all 2/3 of Canada's population does reside in these two provinces."
Interestingly, my buddy and I had a chat on PSP Investments reviewing its currency hedging policy right now and we both agreed that PSP should stay put and stick to its 50% hedging policy but do some tactical asset allocation based on big moves in the CAD.

He also told me that "CPPIB should be the one reviewing its hedging policy" and move to the one PSP implemented while I was there back in 2005. "It's false to think CPPIB doesn't have a hedging policy. It does, it's long USD. It has to buy USD to fund investments or emit debt in USD to fund them. Either way, that long USD trade is getting long in the tooth."

[Note: The euro is rallying Friday along with U.S. bonds, which is strange and might be driven by Dudley's comments earlier today.] 

Can the loonie overshoot and fall to record low territory? Sure it can, it's a petro currency and it can overshoot just like oil can overshoot to the downside but keep this in mind, something my buddy told me:
"The long term trend exchange rate for the loonie is 80 U.S. cents. So right now, it's cheap and this creates opportunities for U.S. and global investors to come buy our stocks, bonds and real estate at a discount. Can it go lower? Sure, especially if a global crisis hits, but I wouldn't place big bets on it going much lower here."
I understand his thinking but I'm worried that oil prices are going to stay low for a long time and there's much more deterioration ahead for the Canadian economy before things pick up, especially if the U.S. economy slows in the second half of the year, at which point the devalued loonie won't help much. This is why my forecast is for the loonie to hit 65 U.S. cents before it settles around 68-70 U.S. cents for a long time.

The truth is the Canadian economy has a lot of structural problems, no thanks to Harper's one way Alberta tar sands bet, and these structural issues need lots of time to work themselves out.

Below, Blackrock Chairman and CEO Larry Fink said Friday the stock market could fall another 10 percent and oil prices could test $25 per barrel. According to one hedge fund trader I know, "OPEC Basket was marked at $25 today, a full 15% below WTI last print."

More interestingly, Larry Fink also weighed in on the shortfall in savings for many Americans as they head into retirement, stating there's a "retirement inadequacy." Larry Fink gets it and I hope he talks about the global pension crisis at the World Economic Forum in Davos next week.

And according to Macquarie Group Ltd.'s David Doyle, Bloomberg’s top-ranked forecaster for the Canadian dollar last year, the Canadian dollar is heading for a record low with the central bank poised to cut interest rates again as commodity prices collapse to the lowest since 1991, manufacturing stalls and consumers remain buried in debt.

He might be right but keep my buddy's comments above in mind. Anyways, enough on loony markets and loonie forecasts. I'm off to take a freezing cold shower and then hit the gym for my Friday leg and back workout. I work too hard and don't get paid enough money to write my thoughts in this blog (Hint: Start donating and subscribing to my blog already!).

Enjoy your weekend and remember to stay cool, calm and collected. Your health is much more important than what is going on in these schizoid markets!!

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