With the U.S. dollar peaking at 11-year highs versus a basket of currencies on Wednesday, and ahead of several major central bank rate announcements, investors would be wise to remain vigilant in a currency war that's being redefined by new monetary policy extremes.
Put simply, the easing programs of the world's biggest central banks are pushing the smaller national banks to react accordingly. Nearly every other week investors are left to figure out the capital market effects of a surprise cut here and there. Investors should be blaming the Swiss National Bank (SNB) which abandoned its tightly defended franc floor in January. The SNB has managed to single-handedly change the rules in today's new currency war.
Over the past two months, central bankers from Singapore to Australia have been surprising markets by cutting their already low rates, while other have implemented negative rates (Sweden, Denmark, and even Switzerland to name a few). The goal of these policy moves is to try to handle the real threat of lower inflation or deflation, sliding commodity prices, and softening growth expectations. It's now become a guessing game every time a central bank meeting convenes, and in some cases, an intra-meeting decision. Already this week Australia surprised and skipped on a rates move, while China sideswiped the market over the weekend and eased for the second time in as many months. In China's case, it could be just the beginning of a new rate-cut cycle as the world's second-largest economy reshapes itself toward a more sustainable long-term growth model.
In the overnight session, it was the Reserve Bank of India's (RBI) turn to flatfoot the market. It announced another intra-meeting decision to cut interest rates by -25 basis points, lowering the repurchase rate to +7.50%, and the marginal standing facility rate to +8.50%. It is the second consecutive easing unveiled by the RBI in this surprise fashion, following the mid-January unexpected -25 basis points easing, and a rate hold in early February. India's policymakers noted softer inflation readings might persist in the first half of the year before firming slightly in the second half, adding that the INR currency has remained strong relative to colleague nations, which is undesirable in that it boosts disinflation. This seems to be the common theme among Tier I and II central banks. The problem with ad hoc or pressured monetary policy moves is that if they do not yield results, it could erode trust in the global central bank monetary regime. This would only dissuade market participation and stoke further investor fear.
There are more rate announcements due this week. The most important is tomorrow's European Central Bank (ECB) monetary policy meet. No fireworks are expected at either the ECB or the Bank of England's (BoE) rate announcement on Thursday, but investors are expecting further details on the ECB's quantitative easing plan in the Q&A portion. Plans to buy eurozone government bonds have already been announced. All that is needed are further details on how the plan will be executed. ECB staff projections for growth and inflation should also be interesting. Lower oil prices mean inflation forecasts could be revised down, while growth should be boosted by lower energy. Nevertheless, this is the script that is currently being used by all central bankers: markets just want to see sustainable rewards.
Later this morning, it's the Bank of Canada's (BoC) turn to take center stage. Last time out, Governor Stephen Poloz surprised the market by implementing an insurance premium -25 basis point cut. Up until a week ago, and after a surprise pause from the Reserve Bank of Australia this week, the market majority had assumed it was a slam dunk that the BoC would be easing today. Poloz reiterated that collapsing oil prices are a "net negative" and a setback for a Canadian economy trying to get back to full capacity and full employment.
Currently, market consensus expects no change to Canadian interest rates, as yesterday's fourth-quarter gross domestic product numbers beat forecasts and do not necessitate an immediate change to policy. Nevertheless, the central bank is expected to be dovish in its rhetoric. The loonie sits atop of CAD$1.2500 compared to the CAD$1.2360-$1.2800 range traded since January's cut. With U.S. yields having rallied strongly of late, the rate divergence argument between the Federal Reserve and the BoC is expected to continue supporting USD/CAD on pullbacks. The market is looking for any signs that the BoC will express its favor for a lower loonie.
The mighty U.S. dollar continues to maintain a firm tone against most currencies with the USD index hitting fresh 11-year highs in the overnight session. Some dealers are noting that the USD index is approaching the +50% retracement level of its global crisis moves from its 2001 highs to the 2008 lows (95.85). Owning the dollar has been a one-directional trade for many months. Tight trading ranges are the relative norm ever since crude prices seemed to have found a temporary bottom over the past few weeks. Already this morning the lower revisions in numerous European purchasing managers' indexes (Spain and Italy) have been adding to the EUR's downward pressure. The 19-member single currency is again probing the lower end of the €1.1100 region seen in January. Better eurozone retail sales data (+1.1%, month-over-month) is helping the currency to avoid the retreat from worsening. Dollar owners will be looking for fresh impetus from ECB chief Mario Draghi tomorrow and from the U.S. nonfarm payrolls print on Friday.
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