If the downward pressure on the loonie from the selloff in commodity prices wasn’t convincing enough to send it below 98 cents, the flat inflation numbers reported Friday morning was definitely the icing on the cake. Over the last few months there has been a tide change in terms of the once robust demand for commodities, and its impact has been visible in the performance of the TSX. Not far behind the lackluster performance of the Canadian equity markets, however, is the deterioration in the Canadian dollar.
A lot of the falloff in our dollar can really be explained by the broad based strength that has come into its US counterpart. With the US dollar soaring to its highest level in three years, it’s once again sparked the debate surrounding how much continued stimulus could come from the US Federal Reserve. Their current bond buying program of 85 billion a month, split between the treasury market and mortgage backed securities is seen by few of the more optimistic District Fed presidents as tapering off by the end of this summer. Although in my opinion, chances of that right now seem quite slim, the Federal Reserve would be in position where they simply reduce asset purchases in a calculated fashion in order to be the least disruptive to the markets.
One major event unfolded this past week that many pundits of the Fed’s QE program were not counting on. That is that the US Treasury’s deficit is looking to be in a lot better shape than many had anticipated. As their finances, for the time being, look to be stronger there is no longer the need for the treasury to issue the same level of debt to finance spending. With Obama’s victory on raising taxes on higher income earners, the treasury’s coffers have been filled for the time being with greater revenues, which has their government spending to appear to be under control. And this as well, has allowed the Congressional Budget Office (a nonpartisan organization) to forecast reduced deficits for the US government in the near term and next few years.
When you describe a situation like the above, it raises the question why wouldn’t we see strength in the US dollar (vis-à-vis Canadian dollar weakness)?
The criticism of the aforementioned rationale for strength in the US dollar is that it paints a very myopic picture of the US economy and does not incorporate a longer term view. For example, there is continued disagreement and debate surrounding how the US Fed will reduce its bond buying program and what affect that will have on the markets. Whether or not the market will actually anticipate some kind of natural rise in long term interests, or if there will be shock and paramount volatility when the day actually comes are questions that are yet to be answered.
What we do know, however, is that the lack of clarity surrounding the approaching finale of the greatest monetary policy experiment in history is yet to be determined. And for this reason, its logical currency markets are very nearsighted as they take in all information they have at the present. This is because there is no answer how this charade will end. With the news of an improving US economy that has surfaced as of late, there should be strength in the US dollar. That was the plan of the US Fed, and the plan is working.
What’s the outlook for the dollar? Well that’s another story.