MONTHLY FX STRATEGY CONFERENCE CALL The Stars Have Aligned for CAD April 2010 Camilla Sutton, CFA, CMT Currency Strategist 416‐866‐5470
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Private and Confidential: For discussion purposes only
SCOTIA CAPITAL FORECAST FX ‐ CAD expected to outperform 2008 2009 2010f
2011f
REAL GDP ‐ A return to growth 2008 2009 2010f
2011f
USDCAD
1.20
1.05
0.97
0.95
US
0.4
(2.4) 3.6
2.8
CADUSD
0.83
0.95
1.03
1.05
Canada
0.4
(2.6) 3.3
2.8
USDMXN 13.00
13.10
13.20
13.70
Mexico
1.3
(6.5) 4.2
3.5
EURUSD
1.42
1.43
1.38
1.45
Euro Zone 0.8
(4.0) 1.3
1.1
GBPUSD
1.46
1.62
1.53
1.60
UK
0.7
(4.8) 1.5
1.1
USDJPY
88
93
92
88
Japan
(0.7) (5.2) 1.6
1.1
USDCNY
6.80
6.80
6.40
6.00
China
9.0
9.0
INFLATION ‐ Contained
8.7
9.5
INTEREST RATES ‐ Begin to rise
US
3.8
(0.3) 2.5
2.4
Canada
2.4
0.3
2.2
1.8
COMMODITIES ‐ Yearly Averages
Q1/10 Q2/10 Q3/10 Q4/10 FED
0.25
0.25
0.75
1.25
BoC
0.25
0.50
1.00
1.50
ECB
1.00
1.00
1.25
1.50
Oil
100
62
83
87
BoE
0.50
0.50
0.50
0.75
Gold
872
975
1,100
1,000
BoJ
0.10
0.10
0.10
0.10 1
GLOBAL THEMES IN FX Current FX Drivers and Themes 1.
Sovereign risk
2.
Interest rates / monetary policy
3.
Relative economic outlook
4.
Broader USD forecast
5.
Sentiment & flow
Currency Returns vs USD, Year‐to‐Date
Group 1
Group 2 Group 3
Year‐to‐Date Returns Highlight Specific Themes Group 1: Commodities, investor sentiment, sovereign risk and ties to US Group 2: Individual stories – CNY peg; JPY & risk aversion; CHF intervention Group 3: Uncertainties, fiscal concerns & investor sentiment
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THEME 1: SOVEREIGN RISK Net Debt & Primary Budget Balance
Net Debt & GDP less cost of finance120
120
Japan
100
Greece
Greece Portugal 60 Germany
Britain Spain
Ireland
40
Canada
(8)
(6)
(4)
20
(20)
‐Sweden
(6)
2
Source: The Economist, OECD, IMF & Scotia Capital
GDP less cost of finance
Canada Australia France (4)
(8) Britain (6)
Spain
(2)
4 2
(20)
‐
Australia Sweden 2
4
Ranking of Sovereign Risk Sweden Switzerland
‐ Germany ‐
Portugal (2)
Greece
(2)
Source: The Economist, OECD, IMF & Scotia Capital
GDP less cost of finance & Primary Budget Balance
Japan
(4)
GDP less cost of finance
Primary Budget Balance (cycl adj)
US
Switzerland
‐
‐ Australia (2)
Ireland
France US 60 Germany Britain Spain 40 Canada
Switzerland
20 France
Portugal
Net Debt
Net Debt
80
80
US
Japan
100
2
‐The worst contain no surprises: Greece, Portugal, Spain, Ireland, UK & US. ‐The best include Canada, Switzerland, Australia and Sweden.
(4)
Currency implication
(6)
CAD, CHF & AUD poised for outperformance.
Ireland Primary Budget Balance (cycl adj) Source: The Economist, OECD, IMF & Scotia Capital
3
THEME 2: RELATIVE CENTRAL BANK MONETARY POLICY INTEREST RATES ‐ Begin to rise Current Q2/10 Q3/10 FED 0/0.25 0.25 0.75 BoC 0.25 0.50 1.00 ECB 1.00 1.00 1.25 BoE 0.25 0.50 0.50 BoJ 0.10 0.10 0.10 RBA 4.25 4.50 4.75
Scotia’s Central Bank Forecast
Central Bank Policy Q4/10 1.25 1.50 1.50 0.75 0.10 5.00
Q411 2.50 3.00 2.00 1.50 0.50 5.25
‐Tighter rates are on the horizon as there is a global shift away from emergency levels.
‐Reserve Bank of Australia in the midst of their tightening cycle. ‐Bank of Canada should enter hiking cycle in June (Q2). ‐Fed expected to increase rates in Q3, but paying interest on reserves will also be important policy tool. ‐ECB difficult balancing act. Expect first hike in Q3 at earliest. ‐Bank of England remains dovish as does Bank of Japan.
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THEME 5: BROADER USD WEAKNESS STORY STILL INTACT OVER MEDIUM TERM
Major Drivers of USD Still Negative 1) Current account deficit 2) Fiscal account deficit 3) Vulnerability as a reserve currency
Implication for USD ‐USD rallies will prove temporary 5
USDCAD DRIVERS USDCAD Drivers I.
Interest rate spreads
II.
Domestic fundamentals
III.
Global growth outlook
IV.
Broad USD movements
V.
Oil & commodities
VI.
Flow
VII.
Sentiment
VIII.
Technicals
Current CAD Correlations
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USDCAD DRIVERS ‐ FUNDAMENTALS – CANADA IS WELL POSITIONED January GDP Highlights A Broad Recovery Other Public sector Finance and insurance Retail Wholesale Manufacturing Construction Utilities Mining, oil & gas Agriculture and forestry All industries ‐0.2
AAA
0
0.2
0.4
0.6
Relative Fundamentals are Strong ‐Broad based growth ‐Stronger than expected employment, consumer & investment. ‐Inflation beginning to firm. Implication for CAD Supportive of CAD sustainably at parity.
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USDCAD DRIVERS ‐ FUNDAMENTALS – CANADA IS WELL POSITIONED Current Account Forecasts
Canada is fundamentally well positioned ‐Current account negative, but trend is improving. ‐Current account of Eurozone hides huge imbalances. ‐World imbalances are shifting, but not necessarily improving.
‐Canada is well positioned fiscally. Fiscal Account Forecasts
‐CAD will be rewarded for this fiscal position.
Implication for CAD Longer‐term fundamentals are supportive of CAD strength.
8
USDCAD DRIVERS – GLOBAL TRENDS FAVOUR CAD FX Reserves Held in Non Majors – Including CAD
Global Trends in FX Reserves ‐Strong fundamentals, open economy, the desire to diversify away from USD has led to increasing focus on the potential of CAD as a reserve currency. ‐The trend is in place – global reserve holders are diversifying. ‐This is a positive for CAD. ‐Limits to CAD’s potential as it is a relatively small economy and bond market. ‐FX reserve managers are looking for preservation of capital and extensive liquidity. ‐CAD ranks high on capital preservation, but poorly on liquidity.
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USDCAD DRIVERS ‐ INTEREST RATE SPREADS Interest Rate Spreads ‐Currently an important driver of USDCAD, however traditionally has been a mixed driver. ‐Changing Bank of Canada expectations and developments in US bond markets have been driving 2‐year spreads in against USDCAD (in favour of CAD). ‐Correlation can break‐down at any time.
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USDCAD DRIVERS ‐ OIL USDCAD vs Oil
Oil Markets ‐Driven higher by emerging market led growth and investors seeking to diversify into commodities. ‐Correlation with CAD holds fairly well over time; though variable in the short‐term.
CAD’s Rolling Correlation with Oil
‐Expect oil to grind higher, which will weigh on USDCAD (CAD strength). ‐Oil forecast for 2010 is for it to average $83. ‐Year‐to‐date oil price average is $79.42, which implies upside from current levels.
‐Oil forecast is positive for CAD.
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USDCAD DRIVERS – SENTIMENT & FLOW Speculators Are Bullish CAD
Sentiment is Bullish CAD ‐The net long CAD position is largest held against USD and reflects bullish investor sentiment (top chart). ‐Global investors are eager to buy Canadian assets (bottom chart).
M&A Activity ‐Large public headline deals (“hollowing out of Canada”) are a relative rarity now. International Securities Transaction – CAD Positive
‐Credit crunch, tighter global liquidity and a weak USD / strong CAD has slowed deal, but potential is still strong.
Implication for CAD ‐Flow & sentiment are positive for CAD.
12
USDCAD DRIVERS – TECHNICALS Seasonality of CAD Highlights Strong Springs
Technicals Support CAD Strength ‐Seasonally CAD has made big gains in the spring – chart reflects average of last 10yrs. ‐Downward USDCAD trend is in tact. Pace is slowing, but no key warnings. ‐Expect hovering either side of parity as market adjust to new reality. ‐General downward USDCAD trend to stay intact over time (stronger CAD).
USDCAD’s Trend is Downward
13
USDCAD DRIVERS – BROADER USD MOVEMENT Last time CAD went to Parity the USD was Broadly Weaker….This Time The USD is Broadly Stronger FX returns against the USD six months leading into parity in 2007.
FX returns against the USD six months leading into parity in 2010.
‐The broader move in the USD has not been supportive of CAD’s move to parity. ‐In 2007 the broader USD move was supportive of CAD at parity. ‐However, that might make this move to parity more sustainable. ‐BoC also sees a difference between a strong CAD based on a weak USD and a strong CAD based on fundamentals (Type 1 and Type 2 factors).
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USDCAD AT PARITY – A COMPARISON TO 2007
15
USDCAD AT PARITY – A COMPARISON TO 2007 USDCAD at Parity Then and Now ‐Speed to and through parity was very fast in 2007. ‐Market more prepared this time. ‐Last time USDCAD overshot (in typical currency fashion). ‐This time expect hovering either side of parity for longer as momentum to parity wasn’t as strong. ‐Financial crisis derailed CAD strength, but then retraced panic move. ‐Base case is for ongoing CAD strength.
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USDCAD DRIVERS – THE BANK OF CANADA Rise in CAD Concerns BoC 2007 BoC Response to CAD Appreciation
BoC is uncomfortable with a Type 2 move to parity; more comfortable with Type 1 move to parity, which we have. Type 1 – fundamental and driven by aggregate demand. Type 2 – ‘other factors’, including risk aversion, broad based USD movement, etc. There is more of a need for policy makers to respond to type 2. Potential responses: 1) Leave monetary policy looser for longer. 2) Verbal intervention. 3) Physical intervention – unlikely. 4) Quantitative easing – unlikely. 17
SCOTIA’S GLOBAL FORECAST AND OUTLOOK FX ‐ CAD expected to outperform 2008 2009 2010f USDCAD 1.20 1.05 0.97 CADUSD 0.83 0.95 1.03 EURUSD 1.42 1.43 1.38 GBPUSD 1.46 1.62 1.53 AUDUSD 0.70 0.90 0.97 USDJPY 88 93 92 Currency Forecast Path
Global outlook
2011f 0.95 1.05 1.45 1.60 1.00 88
CAD expected to hover either side of parity with a bias to appreciate. EUR and GBP remain weak in the near‐ term, weighed down by uncertainty; but regain strength against the USD in the second half of the year. JPY – near term factors, including flow, sentiment and technicals should see yen continue to weaken, before it stabilizes later this year and into next. AUD – like CAD has all the fundamentals in place to perform well in 2010. CNY allows some appreciation in the yuan – but not an overnight revaluation.
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RISKS TO OUTLOOK
1.
US cannot credibly explain how they will introduce fiscal responsibility.
2.
EU sovereign fears become a full blown EU crisis.
3.
Current monetary policy lays groundwork for next crisis.
4.
Inflation emerges ‐ central banks are behind the curve; they begin to tighten policy aggressively and the global recovery is thrown into jeopardy.
5.
Asset bubbles ‐ China’s bubble pops, with global ramifications including the potential for CNY to be devalued further; or Canada has a housing bubble.
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SCOTIA FX RESEARCH SUMMARY Written Research Provided by FX Strategy
FX Strategy
Daily Update – Issued daily at 7:45am (ET)
Camilla Sutton, CFA, CMT
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Currency Strategist (416)866‐5470
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Monthly Conference Call Twenty minute update on FX strategy with emphasis on USDCAD outlook and forecast
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