Dollar-Bloc Update

Bank of Canada Governor Carney delivered a speech on Monday that strongly hinted that the tightening bias will be dropped at next week's rate meeting on October 23.  This is also likely to be the theme of the Bank's monetary policy report the next day.  

Carney explained that in highly uncertain economic periods, business reduces spending and employment plans.  He unequivocally indicated that next week's statement will take this into account.  His comments follow on the heels of last week's IMF cut of its world growth forecasts.

The remarks also coincided with the release of the Business Outlook survey that saw cuts in investment and hiring intentions.  The net percentage of firms anticipating an increase of sales over the next twelve months has fallen from 35% in Q1 to 15% in Q2.  Monday Q3's figure was reported at zero.  

At the end of the week Canada will report its September CPI figures.  Price pressures remain moderate in Canada, with the central bank's preferred core rate likely to slip to 1.4% from 1.6%.  It aims to keep inflation near the middle of a 1-3% band.  Headline inflation is running just below the core rate.  In any event, the price data and the survey data, coupled with the global uncertainty (e.g.,US fiscal cliff, European debt crisis, China slowdown) would indicate that any talk of tightening due to the closure of the output gap is premature.   

The threat of a rate hike in the coming months and quarters never seemed particularly credible to us, but until now Carney did not back down.  From early June through mid-September, the Canadian dollar appreciated by about 8.5% against the US dollar.  It is moving sideways after giving back around 2.5%.  Technical indicators are not generating strong signals presently.  The less hawkish and more neutral signal from the central bank, coupled with the still large speculative position, inclines us to favor the downside of the Canadian dollar in the coming weeks.

The minutes from the Reserve Bank of Australia earlier this month left little doubt that it is poised to cut the cash rate again early next month.  It recognizes that growth over the coming year is likely to be weaker than it previously anticipated.  It remains concerned about the global outlook.  China absorbs about a quarter of Australia's exports and of this, nearly 2/3 is iron ore.  The volatility of industrial commodity prices discourages new investment.  

In this context it is interesting that iron-ore producer Fortescue anticipates that with the leadership change in China next month, the economic stimulus that will likely follow will help iron prices stabilize at higher than prevailing levels.  The next hurdle is the Oct 24 inflation report.  Only  a significant upside surprise that alters the RBA's assessment would prevent a 25 bp cut in the cash rate from 3.25%, which would be the sixth in the past year.  Real rates will remain decidedly positive in Australia, unlikely many other high income economies, giving authorities scope to cut rates into 2013.  

The Australian dollar has not finished the North American session above $1.0275 thus far here in October.  Resistance extends toward $1.0320.  The Australian dollar's modicum of resilience stems from the fact that there may be a demand from reserve managers. In addition, in recent week's gross longs at the IMM futures have been slashed by a third and this may have cleared the decks sufficiently for bottom pickers to emerge.  

New Zealand reported lower than expected price pressures.  Consumer prices rose 0.3% in Q3.  The consensus expected a 0.5% increase.  This translates into a 0.8% year-over-year rise rather than 1%.  This represents the least inflation in New Zealand in a dozen years.  The central bank targets inflation in 1-3% range, preferring something near the middle of that range.  

While it is tempting to think the RBNZ can cut rates at the October 25 policy review, it is unlikely.  The RBNZ looks at two baskets of goods.  Inflation in the tradable basket, which is influenced by the currency and fuel prices, was unchanged on the quarter and off 1.2% year-over-year.  More importantly for the central bank, price pressures are somewhat more evident in the non-tradable basket.  Prices here rose 0.5% on the quarter.  This translates into a 2.3% year-over-year pace, which is slowest in more than a year.  Should prices continue to moderate, the RBNZ will have greater scope to cut rates in early 2013.

The New Zealand dollar has held above yesterday's lows near $0.8130.  A trend line drawn off the June and September lows comes in now just above $0.8100.  A break here could spark another cent loss.  The Australian dollar lost about 5.5% against the New Zealand dollar since late July and a correction is unfolding.   The Aussie is moving above NZD1.26 for the first time since late September and there is scope for NZD1.27-NZD1.28.