The market is breathlessly awaiting to hear from the Governor this week to get a better read of where he stands with respect to policy now that the Bank has moved twice on interest rates and seen the currency appreciate significantly. After Deputy Governor Lane stunned his prairie audience with a post-speech remark that the Bank would be watching the currency closely post its recent run, I suspect the market will pounce on any glancing comment the Governor makes about CAD.
As a trader, I get it. As someone trying to get a grip on future policy decisions, what the currency does over a minute, an hour, a day, a week or even a month is just not that important. Why is that? These are periods of time that are too short to have an impact on real growth. One only has to read Lane’s speech to get an understanding of the number of things other than CAD/US that impact trade over the policy time period that the Bank really cares about. Not to mention that the exchange rate has implications across the economy not just on trade. Stronger Canadian dollar..bad for exports (maybe) but good for capital investment (maybe), the two things that the Bank said they would be watching carefully when determining future policy.
To exaggerate, the market believes that at 1.28, the Bank is content but at 1.22 they are concerned. The point is that they will only be concerned a quarter to two from now when they have sufficient economic data to tell them that they should have been concerned now. As Lane said in his speech, but maybe did not emphasize in the Q&A, they will watch how the economy responds to higher rates and a stronger dollar. They will not base policy on how some people think the economy will respond. I am not convinced that they have seen enough evidence yet of the impact of this year’s appreciation of the loony on the economy. They will be watching the data closely (as they always do) as it unfolds over the coming months and their target interest rate will be calibrated to account for the impact sometime in mid 2018, if necessary, to get the economy to glide back down to potential.
My final observation, again to be found in Lane’s speech, is the graph depicting their new measure of the Canadian effective exchange rate (CEER). This new measure includes a broader set of countries and accounts for both bilateral trade with another country and the competition Canada faces from other countries that trade in the same good with that country. So its not just how competitive the going level of CADUS makes us in the US, but also how competitive the peso is making Mexico, for instance, when an importer in America is looking at his/her options. From a historical perspective, what does the graph going back to 2000 show us? This new index has traded in a range between 95 and 140. In the early 2000s, CAD was too weak which led to the creation of a fragile export sector, one that was not based on real economic fundamentals and collapsed quickly when the currency appreciated. Then just prior to the crisis, the currency was responding to a surge in energy prices and was too strong which resulted in the gutting of even some very competitive firms.
If history is a guide then, the takeaway is that the index at 95 obviously represents a level that is too weak and at 140 it is obviously too strong. We are currently sitting just above 120. It is above the mid point but I wouldn’t want to say that it is in the red zone quite yet.
What is the Gov going to say? My bet is that it will be the usual. He will repeat what was in Lane’s speech, not what was said over coffee.
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