Sentiment in global financial markets has eased compared to the first trading day of the week, with the majority of equity indices giving back a portion of the gains achieved yesterday. The overnight Asian session was weaker on the whole, with the Japanese yen clawing back its losses in earnest, and thus acting as a weight on Japanese stocks. The Nikkei finished lower by close to 0.4%, while USDJPY has crumbled by almost 1% as we go to pixels, on comments from Bank of Japan Governor Kuroda that may have signaled the central bank’s potential for a greater reliance on making adjustments to overnight interest rates as opposed to increasing the monetary base on a go forward basis. By indicating that lower interest rates will be pursued to close the output gap as opposed to continued expansion of the monetary base, market participants are skeptical a further foray into the realm of negative rates will be sufficient enough to boost trend growth in the Japanese economy, and subsequently we’ve seen a continued demand for the resilient yen.
The euro was not able to find a strong catalyst to buck yesterday’s weakness against the big dollar, and as such has remained bound to a relatively tight range, witnessing selling pressure on any upward momentum. After Monday’s PMI data that saw purchasing manager activity slide to 15 month lows, the reading on the business climate in German as polled by Ifo slipped below expectations, with the current economic climate weighed down by future expectations. This could be coming from the fact that fourth quarter GDP in Germany, which came in at 0.3% on a quarterly basis, was largely driven by domestic demand and government spending, with the current loftiness of the euro to do little in the way of stimulating the export sector for the largest economy within the common currency bloc. These developments add further credence to the assumption that Draghi will be looking to tweak monetary policy into more accommodative territory when the ECB meets in early March, and thus we could start to see some froth culled from the common-currency if the economic indicators continue to print to the downside ahead of the next meeting.
The Canadian dollar showed its resilience against its neighbour to the south yesterday, stretching its legs as oil prices rallied on projections from the International Energy Agency that oil production from US shale producers could fall by 600k barrels per day in 2016. The combined effect from the optimistic IEA report and the decline in rig count that was reported last Friday brightened the fundamental outlook for the black gold, helping the front-month WTI contract vault higher. The technical picture for Texas Tea has become more constructive with the break above the downward sloping trend that has been in place since Q4 of 2015, though sustained follow-through will be needed for the bulls to make a run at what is likely to be strong resistance around the $35 level. At the same time, while rig closures are continuing to tally in the US shale region, production numbers have yet to follow suit. While we do recognize there will be a lag time to where the capitulation in unprofitable wells results in production decreases, we have yet to see that materialize in the reported numbers. Therefore, market participants could be disappointed if production numbers show stickiness before the supply and demand equation begins to show signs of getting back to equilibrium.
The price action in the loonie yesterday showed that participants were more focused on the positive developments in the energy markets, not reacting too negatively to the downbeat economic forecast from Finance Minister Morneau. Referencing projections during campaigning that were “too rosy”, Morneau slashed forecasted GDP growth in 2016 from 2.0% to 1.4%, in-line with the Bank of Canada, while increasing the projected budget deficit in 2016-17 to $18.4bln, up from the $3.9bln originally forecast in November. Furthermore, the increased deficit projections are yet to factor in the spending plans which will be outlined in the March 22nd release of the budget, where the Liberals had previously agreed to $10bln per year in infrastructure spending over a three year period in efforts to stimulate the economy. While the picture for Canada in early 2016 isn’t pretty, it’s not entirely surprising either given the lingering of low commodity prices. The challenging part for Canada is that if the Liberals choose to devote more funds to spending on infrastructure in an effort to buffer the national slowdown, they risk pushing their budget deficit further into the red, and risk the ability to reign it in over the previously promised three-year period. The larger than expected budget deficit when excluding spending could derail hopes of any more stimulus spending above the $30bln over three years that has been agreed to, and thus effectively put Poloz and the Bank of Canada back in the hot seat. The next Bank of Canada meeting is on March 9th, and currently the probability of an interest rate cut sits at roughly 20%. Although the meeting would take place before the spending plans of the Federal Government are released, we would place the odds of a rate cut slightly higher given the effect the lingering nature of low commodity prices will have on the broader economy.
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