The National Bank of Canada | Apr 05, 2012 04:20AM ET
• The euro is holding firm for now, with liquidity injections by the ECB and a tentative agreement on an enlarged bailout fund helping to boost confidence. But investors may be grasping at straws and underestimating the gravity of the situation in Europe. The eurozone recession is likely to worsen over the near term and political uncertainty will grow with forthcoming elections and referendums, putting into question the effectiveness of any bailout fund.
• After being hammered in Q1, the US dollar seems well placed for a rebound. The US economy is on a clear uptrend and the likelihood of further liquidity injections is diminishing. Moreover, thanks to the European economic situation, the likely return of safe haven flows should keep the greenback well bid over the next few quarters.
• The Canadian dollar is benefiting from the ramp up in oil prices and a slightly less dovish central bank. While we remain CAD bulls over the longer term, we anticipate a near-term retreat for the loonie (and other commodity currencies) as concerns about global growth make a comeback.
Investors seem to be grasping at straws when it comes to European economic news. Most recently, it was the German IFO that brought cheers (of course, temporarily). The increase of a sovereign bailout fund to a reported €800 bn also brings new hope. So much so, that even speculators are cutting their short positions and helping lift the euro in the process.
Moreover, despite the so-called agreement by European Finance ministers on a €800 bn sovereign bailout fund, implementation is likely to be as tricky as ever. Germany isn’t enthusiastic about raising the bailout fund to such levels, and even if it forces itself to play ball, €800 bn won’t be enough to bail out the likes of Italy or Spain. Comes a point, markets will realize that the eurozone’s future hinges not on the size of bailout funds, but rather on the ability of its policymakers to pass significant structural reforms and generate economic growth. And that takes time. US dollar down in Q1, but not out “Risk on” ruled supreme in Q1, with global stock markets generally seeing strong gains. And not surprisingly, the US dollar underperformed all major currencies besides the yen. But don’t bury the greenback just yet.
As we pointed out earlier, the European economic picture should darken in coming months. Moreover, concerns about China could grow further over the near to medium term. We are not anticipating a hard landing for the world’s second largest economy, expecting authorities there to make use of the significant monetary and fiscal policy room at their disposal. That said, a hit to exports (thanks to weak European demand), coupled by a moderation in domestic construction should limit China’s GDP growth to around 7.5% this year, the first sub-8% reading since 1999.
With growing concerns about global growth, and the euro falling back to earth, perceived safe havens such as the US dollar should benefit. And investors may flock to US assets not just for their relative safety, but also for their appeal, given a much sounder economic backdrop on this side of the Atlantic. Employment creation is gathering speed and the manufacturing sector in particular seems to have regained its vigour. Indeed, momentum from the end of last year carried over into 2012, if the ISM manufacturing index is any guide. So much so that US growth is tracking a respectable annualized pace of around 2% in Q1, on top on Q4’s healthy 3% print.
Canadian Dollar Rebound
While the Canadian dollar failed to gain traction in Q4 despite soaring oil prices, it behaved much differently in the first quarter of 2012, more than making up for lost ground in the prior quarter. The ramp up of net speculative long positions certainly helped boost the loonie in the quarter.
Another piece of good news for the economy and hence the Canadian dollar was the Federal budget which showed somewhat fewer cuts to spending than expected. An improved economic outlook coupled with savings from attrition and modest cuts mean that Canada is well on track to eliminate its budget deficit by 2016 without materially harming growth in the process. The improved fiscal position certainly reinforces Canada’s AAA status.
That said, while we remain CAD bulls over the longer term, we anticipate a near-term retreat for the loonie (and other commodity currencies) as concerns about global growth make a comeback.
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