Interview given to Pro Finance by Stephen Malyon, currency strategist at Scotia Capital. 20.03.2008.
Persistent selling pressure on the US Dollar has helped the EUR/USD to set new life-time highs. A number of other currencies also benefited from the dollar's decline, though the Canadian Dollar has been obviously left behind despite the positive trend in commodities. It seems that the resilience of the Loonie was conditioned by the monetary policy of BOC. Could you share your interest rates forecasts with us?
We suppose that the Bank of Canada will continue to reduce rates, at present our forecast is 50 b.p. decrease at the nearest meeting and the subsequent monetary policy easing that will be less aggressive than in USA, though. I agree that the position of the Central Bank has capped the uptrend in Canadian dollar lately. When you look at a number of currencies and how they have been performing against the US Dollar, you could notice that the Canadian dollar and the British pound showed the worst results due to the rates decrease in these respective countries, as the possibility of monetary easing in G10 countries is considered to be a negative factor.
We haven't noticed the clear signals of economic conditions worsening outside the USA yet, while the economic picture in the States continued to deteriorate. Do you believe that the slowdown of the American economy will have only limited impact on the other countries?
I think that the slowdown in other economies will be more pronounced than we see now, though it won't be as deep as we see it in the USA now. Keep in mind that from the cyclical point of view the US economy is ahead of the much of the rest of the world. If you look back you will see that the FED was raising rates while a number of central banks of some other developed nations actually were lowering rates or kept them steady. Finally those rate increases began to curb growth and the correction on the housing market led to the economy slowdown, while the rest of the countries were still in a growth mode. What we see now is the development of this model: the US economy is started to slow down or may be fell into recession, while the other economies are still growing strongly by comparison to the US economy. Though we will start to see the evidence of a slowdown that will become more obvious in the second half of this year and in the beginning of the next year.
The reports of the financial companies is considered to be one of the key drivers on the foreign exchange market, particularly, the situation in Bear Stearns was far from positive. But Lehman Brothers and Goldman Sachs on the contrary were rather optimistic. Do you think that we are over the worst or there is still no place for over-optimistic conclusions?
I believe that the next several quarters still have a number of negative reports in store for us. The recent reports show that about half of the residential write downs have now been undertaken and so the economists really saw the light at the end of the tunnel. It is difficult to say whether it is true or not, as I do not have enough sophistication to know how much more they will have to write down on the residential MBS side. Moreover a number of other credit classes could be at risk due to the worsening economic outlook and tightening on the credit market, such as commercial mortgage-backed securities, student loans, auto loans. The credit market crisis may be coming to a midpoint or may bó moving to the second half of the cycle, anyway, I believe, that the negative news are not over yet.
As of lately the news about write-downs came mostly from the US banks and several European banks, but we haven't heard of any such cases in Canada. Is Canadian dollar exposed to the risks in this respect?
Actually, some big Canadian banks have also written down relatively large amounts of assets, but, surely, they are incomparable to those in the USA. I do not have enough information either about the Canadian banks exposure or the volumes of possible write downs, though it is obvious that the credit conditions have tightened in a number of countries and the Canada is not an exception. The market rates have not changed despite the Central bank's easing, which will lead to the economic slow down. As you noticed, the most part of the negative reports came from the USA, though, speaking in terms of currency moves, lots of negative news has been already priced in the dollar rate, moreover, it is not clear what is going to happen to the Canadian growth and what is going to happen to the European growth. I don't think it would be wrong to say that the number of such messages will start to decrease and by the end of the year we might find ourselves in a situation when Fed is over with monetary easing while the other central banks are only in the midst of their rates cut campaign. No doubt that that could pressure those currencies. I think that the Canadian dollar growth has been limited due to the close correlation between the Canadian and the US economies and the growing perception that the US slowdown will not go unnoticed to the rest of the world; also the concerns are deepened in relation to of impact of the world economy slowdown on the commodity prices.
You mentioned the commodity prices. In the past they provided good support to the Canadian dollar. Do you think they will be among the positive factors for the currency in the short-term and the long-term perspective?
It's a good question. The Canadian dollar failed to benefit from the rally on the commodity market even though the US dollar has been losing ground. We feel that the situation on the commodity market will remain positive mainly due to the supply side pressure. This factor together with the US dollar weakening and the inability of Fed to fight inflation caused this flight to safety to the commodity market and drove the prices higher. Though we do think that the Fed is right to expect the US inflation to slow down, and if we see the decrease of the inflation pressure in the US, some speculators on the commodity market might step back and if combined with the economy slow down not only in the USA, but also in the other countries this could muff the positive mood on the commodity market. We are not looking for the global economy falling from a cliff and feel that the commodity prices will remain relatively high, though, I believe that there is some room for correction.
If the inflation pressures decrease the Fed will have a chance to lower rates more aggressively.
Yes, now we are expecting that the rates will be lowered 50 b.p., though the forecast is being revised and may be changed to 75 b.p. decrease as the economy is extremely vulnerable, while the Fed made it clear that it is going to do its utmost not only to normalize the credit market, but also to support growth. Sure enough the inflation remains the most important factor in this respect. The latest FOMC statement signaled that the members of the Committee are concerned about the resent data and the inflation expectations measures. It is vital that we don't see this situation to deteriorate further as it will make things a little bit more difficult for the Fed and may force them to take less aggressive position.
So what should we expect form the American currency against, let's say, euro and Canadian dollar?
It is really difficult to be a dollar bull in the short term, though it looks oversold and the consolidation is very likely. Anyway, the uptrend in EUR/USD will be dominant and I think that euro will be supported due to the aggressive Fed rate cuts while the ECB's immovable in its desire to fight inflation and the economic picture in Eurozone is not as dark as in the USA. I think that if the US economic slow down spill over to the Eurozone, while the inflation there moderates so that the ECB rate cut becomes possible, we might see the US dollar recovery, though it is unlikely to be very much impressive. Speaking about the Canadian dollar the situation is a bit more complicated due to the close interrelation of the Canadian and American economies I mentioned before. On one hand, the Bank of Canada is lowering rates, on the other hand the American currency is vulnerable on a broad scale, so I think the USD/CAD will remain in the range for some time now. Further development depends on what the growth backdrop looks like not just in Canada or US, but in the global economy as a whole. Considering the weakness of the American economy and the possibility that the global economy will retreat in the second half of the year, I could say that the Canadian dollar can become under pressure.
Scotia Capital forecasts EUR/USD at 1.50 on a monthly basis, at 1.53 and 1.59 on a 3-month and a year basis. For USD/CAD the forecasts are 0.98, 0.97 and 0.95. (note: the forecasts are being revised).
Mr. Malyon was interviewed by Dmitry Khrabrov ProFinanceService.com