Tag Archive | "Economic Trends"

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Osborne Calls For Bolder BoE

Finance minister George Osborne stated his case for more aggressive and innovative Bank of England initiatives to help the country climb out of the economic rut that has led to a credit downgrade and has the economy on the verge of another recession. His address to Parliament was marred by jeers from Labor and their leader, Ed Millibrand.

While the politics is sticky, the current economic trends point to disaster unless a commitment to growth is in place. Osborne looks to the BoE to carry the ball by giving the economy some breathing room with an already stifling inflation rate.

Osborne made it clear that this was not the time to cut back on austerity. Prime Minister David Cameron and Osborne remain committed to the austerity strategy that is designed to narrow the deficit through curtailing public debt. Many Brits believe their success will determine the outcome of the elections in two years. The deficit reduction package is a five year plan.

Another EU Nation Long On Austerity, Short on Growth

However, as other EU nations have found, austerity without growth is a dangerous formula. Recession looms and the UK manufacturing output is discouraging.

Latest growth projections are dismal. Osborne announced the economy will grow about 0.6 percent this year. The finance minister projects 1.8 percent GDP expansion in 2014. He was quick to point out that the 1.8 percent would exceed the output of Germany and France.

Cameron and Osborne had paid a price politically for the struggling recovery. British sterling took another hit on Wednesday but the prospect of a more aggressive BoE seemed to stabilize equity markets.

Osborne called for the central bank to maintain its 2 percent inflation rate, if possible, but not at the expense of growth. He asked for the bank to devise a strategy to reduce the inflation rate over time if it became necessary to increase the rate by more than 2 percent to supply enough easing to stimulate growth.

Housing and Construction Must Lead Way

Of particular interest is the stagnant construction and housing industry. Osborne’s charge to the BoE would transform the mission to resemble the mandate of the US Federal Reserve, whose controversial three rounds of QE have sparked a slow, tenuous but steady recovery.  US equity markets have flourished in the meantime.

Most troubling in Osborne’s presentation is his paring of the 2013 GDP growth. The 0.6 percent is half the original 2013 projection of 1.2 percent.

Osborne said, “As we’ve seen over the last five years, low and stable inflation is a necessary but not sufficient condition for prosperity. The new remit explicitly tasks the MPB with setting out clearly the tradeoffs it has made in deciding how long it will be before inflation return to target.”

It looks like uneasy times are ahead for the Sterling and the UK economy.

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Economic Theory Implies Canadian Dollar will Fall

Sometimes I wonder if I’m living in the clouds. All of my recent reports on the Canadian dollar were twinged with pessimism, and I argued that it would only be a matter of time before reality caught up with theory. While the continued surge in commodities prices has confounded everyone’s expectations, but other economic trends continue to work against Canada. In other words, I think that there is still a strong argument to be made for shorting the loonie.

To be sure, the rally in commodities prices has been incredible- nearly 50% in less than a year! Oil prices are surging, gold prices just touched a record high, and a string of natural disasters have driven prices for agricultural staples to stratospheric levels. Given the perception of the Canadian dollar as a commodity currency, then, it’s no wonder that rising commodity prices have translated into a stronger currency.

As I’ve argued previously, rising commodities prices are basically an irrelevant – or even distracting – factor when it comes to analyzing the loonie. That’s because, contrary to popular belief, commodities represent an almost negligible component of Canada’s economy. Canadian exports, of which commodities probably account for half, have recovered from the recession lows of 2009. On the other hand, the value of Canadian exports are basically the same as they were 10 years ago, when one US dollar could be exchanged for 1.5 Canadian dollars.

Consider also that Canada now imports more than it exports, and that the Canadian balance of trade recently dipped into deficit for the first time since records started being kept 40 years ago. Its current account has similarly plunged, as Canadians have had to finance this through loans and investment capital from abroad. Based on the expenditure approach to GDP, trade actually detracts from Canadian GDP. Any way you perform the calculations, commodities are hardly the backbone of its economy, account for about 15% at most.

As if that weren’t enough, the press is full of stories of Canadians that think their own currency is overvalued. Businesses complain that they can’t compete, and that banks won’t lend them the money they need to upgrade their facilities and become more efficient. Meanwhile consumers whine about higher prices in Canada, compared to the US. I think it’s very telling that their is now a 2-hour wait to cross the border from Vancouver, and shopping malls on the American side have reported a huge jump in business. Even the famous Big Mac Index shows that the price of a hamburger was already 12% higher in Canada back when the loonie was still hovering around parity with the US Dollar.

One area that higher commodities prices will be felt is inflation, which is nearing a two-year high and rising. At 3.3%, Canada’s CPI rate is now higher than in the EU. Given that the European Central Bank hiked rates earlier this month, it probably won’t be long before the Bank of Canada follows suit. In fact, forecasters expect the benchmark rate to rise by 50-75 basis points by the end of the year, from the current 1%.

This might excite carry traders, but probably few others. Besides, given that other central banks will probably raise rates concurrently, it can’t be assumed that carry traders will automatically gravitate towards the Canadian dollar. Not to mention that as I pointed out in my previous post, the carry trade is hardly a risk-free proposition. In this case, an interest rate differential of only 1-2% probably isn’t enough to compensate for the risk of a correction in the USD/CAD.

And that is exactly what I expect will happen. The fact that the loonie has shattered even the most optimistic forecasts is not cause for bullishness, but rather for concern. According to the most recent Commitment of Traders report, net long positions are reaching extreme levels, and it’s probably only a matter of time before the loonie returns to earth.

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The Federal Reserve – Wait & See?

The Federal Reserve governors appear divided about the meaning of certain economic trends.  The Fed’s August 11-12 policy session was optimistic but tempered with caution.  The minutes of the meeting indicated that Reserve members felt the risks to the economy had eased, but the trajectory of the recovery, inflation and deflation worries and effective interest rate changes remain tenuous factors that will determine the eventual “exit strategy.”

The minutes included the following analysis; “Meeting participants agreed that the incoming data and anecdotal evidence had strengthened their confidence that the downturn in economic activity was ending and that growth was likely to resume in the second half of the year.”

The consensus is that the current recovery will be modest and the chance that the recession will resemble a “W” rather than a “V’ is strong.  As a result, the Federal Reserve has determined to stay the course on certain stimulus spending despite inflationary risks.

Al Dales of Capital Economics in Toronto offered the following observations; “The Fed is in no hurry to alter its current policy stance.  The Fed will complete its asset-purchasing program and remains reluctant to withdraw its policy support soon.”

As of September 2, 2009, the Federal Reserve has bought $792 billion in mortgage-backed securities and $118.6 billion in mortgage agency debt in 2009 alone.  Since the recession began in 2007, the Fed has total purchases of $1.25 trillion in mortgage-backed securities and $200 billion in mortgage agency debt.  These programs are set to expire at the end of 2009.  The central bank did take steps to wind down a $300 billion long term Treasury purchasing program.

Inflation Woes

The bottom line is that there is no quick fix for the economy, which entered the country’s deepest recession in December of 2007.  In fact, the fed seems resolved that the recovery will be slow and prolonged.  The central bank does not rule out the possibility of another downward spike and thus is hesitant to commit to an exit strategy preferring instead to extend certain stimulus investment.

Citing high unemployment and low manufacturing, the Fed does not fear inflation.  However, in speaking with CNBC on Wednesday, Charles Plosser, the Chairman of the Philadelphia Federal Reserve, warned against a potential spike in inflation.  Plosser believes that the Fed may have to raise its favorable interest rates sooner than anticipated. 

Plosser provided evidence of a stronger than expected recovery at the end of 2009 and predicted bigger gains in 2010.  At the August meeting, the Federal Reserve voted to keep benchmark overnight interest rates steady at near zero.

A new American phenomenon, household savings, has combined with the high unemployment and lack of consumer confidence to contain spending. The economy needs a loosening of the consumer’s pocketbooks to stabilize the recovery.

The OECD Weighs In

Early Thursday, the Organization of Economic Co-Operation and Development (OECD) predicted a stronger than expected recovery.  OECD chief economist Jorgen Elmeskov said; “Compared with expectations a few months ago, we now have a recovery which may be coming a little earlier and it may be slightly stronger because financial conditions have improved more rapidly than we assumed a few months ago.”

The OECD predicted a 1.6% expansion of the U.S. economy in the third quarter and 2.4% in the fourth.  These are substantial reversals of the OECD’s June projections.

The OECD also predicted third and fourth quarter improvements in the G-7 economies of 1.2% and 1.4% in the third and fourth quarters of 2009.  Europe’s big winners appear to be Germany and France.  Japan is expected to grow 1.1% in the third quarter.

Elmeskov cited a significant global reduction in unsold homes as a major contributing factor in the recovery.  “In some countries, including the United States, it also looks as if the bottom of the housing market might have been hit a little earlier than assumed.”

The OECD urged economies to continue monitoring quantitative easing policies but to begin developing exit strategies that would include normalization of interest rates.  These rates should begin to rise in the third quarter of 2010.

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