Canada Bulls Feel as If They Hit the Daily Double
(Bloomberg Opinion) -- It’s often said that a currency is to a nation what a share price is to a company. If true, then Canada looks like a raging buy. The Canada dollar is in the midst of its biggest three-day rally since February 2016 against its main peers — and it’s not just because the nation finally came to an agreement with the U.S. and Mexico over the weekend on a new trade deal. The so-called loonie is also getting a boost from news that a group led by Royal Dutch Shell Plc is set to move ahead with a $31 billion liquefied natural gas project on the country’s west coast.
Those two events underscore a string of positive news out of Canada in recent weeks. The Bloomberg Correlated-Weighted Index that measures the Canadian dollar against a basket of nine other developed economy currencies jumped as much as 1.10 percent Monday, bringing its gain over the past three days to 2.76 percent, the most in a three-day period since February 2016. It’s up 3.49 percent the past three months, more than any other currency in the basket, which includes the U.S. dollar, euro and yen. At the same time, the economic data out of Canada is exceeding estimates more consistently than any of the 17 countries and regions tracked by Citigroup Inc. economic surprise indexes with the exception of Switzerland. The upshot is that the Bank of Canada is likely to resume raising interest rates when policy makers meet later this month and again in January. For that reason alone there’s likely to be more upside for the loonie as foreign-exchange strategists, which have been bearish, break out their spreadsheets and calculate new, higher levels for the Canadian dollar. They currently forecast it depreciating to $1.30 by the end of the year, even though it rallied to $1.2783 on Monday, its strongest level since May.
The strategists at Bank of America Merrill Lynch wrote in a report Monday that there’s scope for the Canada dollar to appreciate to $1.26 in short order. “Reduced trade policy uncertainty could potentially reverse the anemic flow of securities investment into Canada,” they wrote. And what about that Royal Dutch Shell deal? The firm and its four partners have agreed to invest in the LNG Canada project, Bloomberg News’s Rachel Adams-Heard and Ryan Collins reported, citing people familiar with the matter. Add it up and you find that Prime Minister Justin Trudeau scored two of the biggest economic victories of his political career in less than 12 hours.
TRADE DEAL HURTS SMALL CAPS
At a press conference Monday to celebrate the new trade deal with Canada and Mexico that replaces the North America Free Trade Agreement, President Donald Trump called it a “historic” victory for the U.S. And at first glance, it looks as if equity investors agreed as they pushed the S&P 500 Index up as much as 0.79 percent. But, as the cliché goes, looks can be deceiving. The S&P 500 is chock full of international companies, which means it’s just as likely that they are rallying on the sense that the new trade accord is little more than a rebranding of Nafta with a few tweaks around the edges and not a revolution. So, if that’s the template for future deals, then there’s nothing to be too concerned about when it comes to international trade and U.S.-led protectionism dragging economic growth down. That might help explain the performance Monday of small-capitalization stocks, which as measured by the S&P SmallCap 600 Index fell as much as 0.91 percent in its biggest drop in two weeks. Smaller companies tend to be domestically focused, so if their shares are getting beat it may be a sign that investors don’t see the U.S.-Mexico-Canada Agreement — USMCA —helping that much.
FARMERS GET A (SMALL) VICTORY
The other thing of note for market participants that Trump said at the press conference is that it’s “a very, very big deal for our farmers.” Farmers certainly hope so. Earlier this year, the U.S. Department of Agriculture forecast that net farm income would drop in 2018 for the fourth time in five years, to $59.5 billion, down from a record $123.8 billion in 2013 and the lowest since 2006. But on Monday the Bloomberg Agriculture Subindex of commodities ranging from corn to soybeans to wheat jumped as much as 1.82 percent in its biggest gain since July. To be sure, the gauge is still down 10.6 percent for the year and 56 percent since mid-2012. One of the big winners among commodities is corn, with futures for December delivery rising as much as 2.9 percent to $3.665 a bushel. The accord alleviates the risk that Mexico, the biggest importer of U.S. corn, will turn to competing exporters such as Argentina, according to Bloomberg News’s Shruti Date Singh. Last year, the U.S. exported $3.2 billion of corn and corn products to Mexico and Canada, according to the National Corn Growers Association. Soybean futures also rose on optimism that the new agreement could herald more U.S. trade deals, especially with China, the world’s biggest buyer of the oilseed.
WHATEVER HAPPENED TO INFLATION?
Longer-term U.S. bond yields are on the rise again, with those on 10-year Treasuries back above 3 percent. Given the strength of the U.S. economy, it’s not hard to understand why investors are shunning bonds in favor of riskier assets such as equities. What is hard to understand is why yields are increasing in the face of some tepid inflation data. According to Bloomberg Economics, each of the five most recent inflation indicators have undershot expectations, ranging from the core personal consumption expenditure index to the import price index. It might seem as if bond investors expect the current inflation data to catch up with the broader economy, but such bets have proved ill-advised time and again in recent years. Arbor Research & Trading data scientist Ben Breitholtz dug into the inflation reports a little deeper and found that the trend appears to be toward slower inflation, which should help support bonds and limit the rise in yields. He found that the three-month annualized rate for the core PCE, which excludes food and energy, fell from a recent peak of 2.2 percent to 1.8 percent in August. That’s important because the Fed targets a 2 percent inflation rate, and if the rate falls further below 2 percent it will take away a big reason policy makers have to keep raising interest rates.
KEEP A CLOSE EYE ON ITALY
It’s becoming clear that fiscal troubles in Italy are starting to damp investor interest in euro zone financial assets. Yields on Italian bonds soared on Monday, with those on two-year maturities jumping 28 basis points to 1.32 percent even though Italian Finance Minister Giovanni Tria sought to reassure his euro-area counterparts about his budget targets during a meeting in Luxembourg. The problem is that Italy’s government late last week agreed to adopt a budget deficit target of 2.4 percent of gross domestic product, above the European Union’s wishes for a 2 percent target. If Italy can decide to ignore the EU’s wishes, what’s to say others won’t as well? That’s why the Bloomberg Euro Index tumbled as much as 0.41 percent, bringing its four-day slide to 1.49 percent, the most since March. France’s Bruno Le Maire said that the EU’s budget restrictions must be respected by everyone while European Commissioner for Economic and Financial Affairs Pierre Moscovici said Italy’s budget amounted to a “very, very significant” deviation from its previous projections and almost certainly violated the rules. Italy, with its $2.3 trillion — yes, trillion — of debt, is rated Baa2 by Moody’s Investors Service and an equivalent BBB by S&P Global Ratings and Fitch Ratings. Those ratings are the second-lowest on the investment-grade spectrum, and some investors say Italy is in jeopardy of being cut to below investment grade, or junk. If so, get ready for a wild ride in markets.
The Federal Reserve raised interest rates last week for the eighth time since December 2015. This week, market participants will hear from a slew of policy makers including Fed Chairman Jerome Powell on Tuesday on the reasons behind that decision and the prospect for more rate increases going forward. As Bloomberg Economics points out, members of the rate-setting Federal Open Market Committee have mostly coalesced around the need for fourth rate increase this year in December, but their expectations for 2019 range from less than 2.25 percent to more than 3.50 percent, with the median standing at 3.1 percent. Also, an equal number of policy makers are anticipating both two and four rate increases.
The Fed’s No Longer Guided by Concept of Neutral Rates: Tim Duy
Bond Vigilantes Won’t Corral Budget Deficits: Brian Chappatta
Why October Isn’t the Scariest Month for Stocks: Barry Ritholtz
Central Banks Can’t Save You in the Next Recession: Daniel Moss
What’s Not to Like About Trump’s Iran Oil Sanctions?: Julian Lee
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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