Monday, January 18, 2016

Currency, Credit, Canucks and Cauliflower Prices

From Bond Economics:
Chart: Canadian Dollar And Bond Yields
Government of Canada bond yields have recently hit (modern) record lows. This is the "pain trade" for most Canadian asset allocators, as this is magnifying their actuarial liabilities, while the consensus underweight of bonds is hurting performance. The outperformance of Canadian bonds also flies in the face of the common wisdom that a collapsing currency is bad for bond markets and somehow limits policy options. Despite the alleged panic of Canadian consumers about the high price of food, the impact of the weaker dollar has been relatively modest (unless you crave cauliflower).
U.S. Policy Paralysis Not Helping
The Canadian economy has been diverging somewhat from trends across the border, but the Canadian outlook would darken even further if the United States economy falls into recession.

Although the hard data so far has not been consistent with a U.S. recession, the latest batch of reports were not particularly buoyant. It is not particularly surprising that the Nonfarm Payrolls number has been unaffected (keeping in mind the limitations of that measure), as the labour market is a coincident indicator of economy. Payrolls will only fall once the economy is already in recession, and that signal will delayed by data lags and the defective nature of its construction. (Some of the job growth in any month is a model estimate of net job creation outside of the sample; those model estimates will be too high during recessionary conditions. No, I have no idea why Street economists focus on that number.)

The decision by the Fed to hike rates now looks even more questionable than it appeared at the time. They hiked rates on the premise that there was a danger of the economy overheating "soon," and that the ongoing meltdown in the commodity markets would have no negative impact on the U.S. economy. All the FOMC can do now is pretend that everything is hunky dory, even though risk markets are now getting smashed on an almost daily basis. They cannot hint of a potential policy ease to counteract these strains, as that would confirm that they had no idea what they were doing when they raised rates just a month ago. This paralysis south of the border is not going to be helpful for already shaky Canadian business confidence.

Currency Moves - So What?
The drop in oil prices has crippled the Canadian dollar. The strategy of ramping up production of extremely expensive oil from the tar sands, in a landlocked location that is cut off from world oil markets has not turned out particularly well. This has impaired the value of Canadian financial assets, and so investor flows have moved against the Canadian dollar. (In my view, the relative attractiveness of Canadian financial assets has been more important for the currency valuation than the trade effect of falling oil prices.)...MORE
....Canadians Panicking About Cauliflower Prices!
I read an article this week with a headline along the lines of "Canadians are panicking about food prices!" (If there were Canadians panicking, I was not one of them. Other than cauliflower I had not noticed any particularly unusual vegetable pricing. See this Toronto Star article for a less excitable example -- "Soaring Cauliflower Prices Come To A Head For Restauranteurs". The headline writers at the Toronto Star are definitely better at that job than I am.) Although there are some nuggets of truth in articles about rising Canadian food prices, they do not present a problem for policymakers.....