Canadian Bonds, The Currency, Together With Cauliflower

Government of Canada bond yields receive got of late hitting (modern) tape lows. This is the "pain trade" for most Canadian property allocators, every bit this is magnifying their actuarial liabilities, patch the consensus underweight of bonds is hurting performance. The outperformance of Canadian bonds also flies inwards the human face upwards of the mutual wisdom that a collapsing currency is bad for bond markets in addition to somehow limits policy options. Despite the alleged panic of Canadian consumers nearly the high cost of food, the impact of the weaker dollar has been relatively pocket-size (unless you lot crave cauliflower).

[UPDATE 2016-01-20] The Bank of Canada kept rates on concord today, which champaign surprised unopen to people (the Canadian dollar strengthened on the news). At this point, the BoC has luxury of waiting to take in what volition happen, in addition to thence I practise non intend they volition practise anything until at that spot is unopen to decisive hard economical information that justifies farther cuts. 

U.S. Policy Paralysis Not Helping

The Canadian economic scheme has been diverging somewhat from trends across the border, but the Canadian outlook would darken fifty-fifty farther if the the States economic scheme falls into recession.

Although the hard information thence far has non been consistent amongst a U.S. recession, the latest batch of reports were non peculiarly buoyant. It is non peculiarly surprising that the Nonfarm Payrolls release has been unaffected (keeping inwards heed the limitations of that measure), every bit the labour marketplace seat is a coincident indicator of economy. Payrolls volition entirely autumn in i lawsuit the economic scheme is already inwards recession, in addition to that signal volition delayed past times information lags in addition to the defective nature of its construction. (Some of the project growth inwards whatsoever calendar month is a model guess of cyberspace project creation exterior of the sample; those model estimates volition move likewise high during recessionary conditions. No, I receive got no thought why Street economists focus on that number.)

The determination past times the Fed to hike rates straightaway looks fifty-fifty to a greater extent than questionable than it appeared at the time. They hiked rates on the premise that at that spot was a danger of the economic scheme overheating "soon," in addition to that the ongoing meltdown inwards the commodity markets would receive got no negative impact on the U.S. economy. All the FOMC tin forcefulness out practise straightaway is pretend that everything is hunky dory, fifty-fifty though direct chances markets are straightaway getting smashed on an almost daily basis. They cannot hint of a potential policy ease to counteract these strains, every bit that would confirm that they had no thought what they were doing when they raised rates simply a calendar month ago. This paralysis southward of the edge is non going to move helpful for already shaky Canadian draw of piece of work concern confidence.

Currency Moves - So What?

The drib inwards crude prices has crippled the Canadian dollar. The strategy of ramping upwards production of extremely expensive crude from the tar sands, inwards a landlocked location that is cutting off from the world crude markets has non turned out peculiarly well. This has impaired the value of Canadian fiscal assets, in addition to thence investor flows receive got moved against the Canadian dollar. (In my view, the relative attractiveness of Canadian fiscal assets has been to a greater extent than of import for the currency valuation than the merchandise effect of falling crude prices.)

The Canadian dollar hitting a value of $0.98 inwards 2013 (that is, 1 USD = 0.98 CAD, or a Canadian dollar is worth to a greater extent than than a U.S. dollar), dropping to $1.4541 on Friday. This is a loss of 32% of purchasing might over a pair of years. Admittedly, it has been an orderly send market; emerging marketplace seat currencies tin forcefulness out lose a lot to a greater extent than value inwards really curt periods. However, that is nonetheless an impressive sell off.

I ordinarily run into arguments that currency markets tin forcefulness out somehow bound policy activeness (other than for the United States, which is allegedly special because of "reserve currency" status). Supposedly, international bond vigilantes volition drive upwards bond yields every bit they demand to protect the value of their holdings (in unusual currency terms). There are no signs of this whatsoever. Canadian bond yields are plumbing novel lows, in addition to Canadian fundamental bankers are dropping hints nearly charge per unit of measurement cuts (to negative levels).

The argue why policy activeness is non constrained is that the effect on the domestic cost grade of currency movements are mild. There are a few pockets of cost increases, but the wide cost grade is driven past times domestic wages. Other than a few especial cases (hockey players,...), workers are paid inwards Canadian dollars, in addition to thence the cost grade shows considerable inertia. I verbalize over this farther below.

Arguably, the weakness of the Canadian dollar does let the Bank of Canada to concord off on charge per unit of measurement cuts. This is helpful, given the proximity of the null bound. Until unopen to major players cut back their crude production, really trivial tin forcefulness out assist the Albertan economy. However, the mass of the population (including yours truly) alive inwards the provinces of Ontario in addition to Québec, in addition to the weaker Canadian dollar is extremely helpful for the prospects of manufacturing exporters -- assuming that our primary sources of import demand avoid recession. Correspondingly, policymakers at the Bank of Canada are inwards a much amend seat than their American counterparts. They did non hike rates inwards the human face upwards of the global commodity meltdown, in addition to they are getting an easing of "financial conditions" via a weaker currency. They simply demand to drib hints nearly negative rates every thence oft to continue the Canadian dollar on its dorsum foot.

That said, the Canadian dollar is likely at a grade that would move considered cheap. Although I tin forcefulness out sometimes read wide currency trends (for example, I moved the bond share of my personal portfolio into U.S. Treasurys a few years ago), I practise non fifty-fifty travail to forecast detail currency levels. The entirely condom thing to state is that the Canadian dollar volition eventually brand a sudden "V-shaped" plough (probably when crude bottoms). Generally speaking, I intend trying to forecast those sudden turns is non a worthwhile investment strategy; it is best to notice an alternative marketplace seat to notice a safer agency to receive got a position. (This is arguably easier to practise inside fixed income; currency traders receive got to purpose options, which leaves them fighting elevated implied volatility.)

Canadians Panicking About Cauliflower Prices!

I read an article this calendar week amongst a headline along the lines of "Canadians are panicking nearly nutrient prices!" (If at that spot were Canadians panicking, I was non i of them. Other than cauliflower I had non noticed whatsoever peculiarly unusual vegetable pricing. See this Toronto Star article for a less excitable example -- "Soaring Cauliflower Prices Come To H5N1 Head For Restauranteurs". The headline writers at the Toronto Star are definitely amend at that project than I am.) Although at that spot are unopen to nuggets of truth inwards articles nearly rising Canadian nutrient prices, they practise non introduce a occupation for policymakers.

The information from Statistics Canada send out that fresh vegetable prices are rising; the latest available information is for November, in addition to the annual inflation charge per unit of measurement for that constituent was 10.9% (chart above, overstep panel). That's a fairly scary grade of inflation, but every bit the nautical chart shows, such a high grade of inflation is mutual for that component. (This is why unopen to economists dearest to pick statistics out of the air without providing a chart; stripping numbers out of context makes them audio scarier than they are.) However, the bottom panel shows the annualised inflation charge per unit of measurement over a 3-year window, in addition to the inflation charge per unit of measurement for this constituent has been running good inwards a higher house the Bank of Canada's 2% inflation target.

The nautical chart inwards a higher house illustrates why the bound of fresh vegetable prices does non pose a detail occupation for policy. The aggregate of all nutrient components of the CPI has been much less affected past times the drib inwards the Canadian dollar, running at a 3.4% annual inflation charge per unit of measurement inwards November. By comparison, the Canadian dollar was depreciating at a 17% annual charge per unit of measurement inwards November. Given that divergence, it is clear that it would move hard to receive got whatsoever confidence inwards estimates of the sensitivity of nutrient prices to the value of the currency. Admittedly, unopen to of the stability reflects the fact that Canadian importers likely undertake currency hedging programmes; fifty-fifty if the Canadian dollar stabilises, unopen to cost rises volition nonetheless filter through the pipeline. Nevertheless, the Canadian dollar is non going to continue falling at its electrical flow stair for years; it volition eventually bounce back, in addition to at that spot volition move a corresponding reversal inwards nutrient cost inflation.

Moreover, Food is likely the constituent of the CPI that is most exposed to the currency. As a result, the aggregate CPI likely ends upwards amongst a really little sensitivity to the Canadian dollar. (We would likely demand to strip out the unloosen energy constituent for such a sensitivity analysis; the value of the Canadian dollar is itself related to the cost of oil.) Given this depression sensitivity, policy makers are largely gratis to non worry nearly the value of the currency amongst regards to hitting their inflation target; the currency entirely actually matters to what extent it affects the prospects for international trade. And this is despite the fact that the Canadian dollar is non a "reserve currency."

As to explicate the lack of currency sensitivity, I discussed food inflation inwards an before article. Like other developed countries, nutrient expenditures inwards Canada are dominated past times spending on restaurants in addition to processed food, in addition to prices for such nutrient are subject upon the cost of labour. (In general, those prices receive got inflated at a faster charge per unit of measurement than less processed foods, which is a outcome of rising incomes.) This is a dissimilar province of affairs than is the instance for many developing countries; those countries were pushed into producing "cash crops," in addition to they unfortunately import cereals. Furthermore, their diets characteristic much less processed food. This may move healthier, but this leaves nutrient prices much to a greater extent than exposed to the cost of raw foods, Correspondingly, policymakers inwards such countries practise non receive got the luxury of ignoring nutrient prices.

Concluding Remarks

Canadian yields receive got hitting levels that I ever had assumed were reserved for JGBs in addition to mayhap Swiss debt. Since I uncertainty that the Bank of Canada would resort to negative rates (since the weaker dollar is doing the stimulus operate for them), I assume that at that spot is non a whole lot of room left for the secular bond bull market. That said, I uncertainty that at that spot volition move a pregnant reversal until at that spot is a sign that the global economic scheme is entering a sustained growth stage (and that the Canadian housing marketplace seat is non weakening).

(c) Brian Romanchuk 2015