Central Bank Statements (Not Actions) Drive The Loonie Lower

Includes: DBV, FORX, FXC, UDN, UUP
by: Dean Popplewell

By Alfonso Esparza

The loonie continues to trade on the back foot this week after Bank of Canada governor, Stephen Poloz commented Tuesday that he couldn't rule out the possibility of a rate cut. After the Reserve Bank of New Zealand raised rates earlier last week this was seen as very CAD negative and the currency lost 0.7 percent.

Yesterday marked the first Federal Open Market Committee led by Janet Yellen. She was praised by most market watchers given the tough act to follow as predecessor Bernanke had some famous fans. Warren Buffett gave the former Fed governor most of the credit for the rally in stocks. Yellen was consulted on the start of the Fed's QE tapering so it was no surprise that she continued with a $10 billion cut of stimulus. What did surprise the market was the overall tone used in her first meeting with the press after the FOMC. The market was expecting a more dovish stance from the FOMC statement and it got that with a low rate pledge for a "considerable time". The mention of a six month timeline in her answers took the market by storm, as it was not expecting such a clear timeline.

The CAD lost another 0.9 percent as Janet Yellen foresees a rate hike as early as next year. Tapering would have to continue at the current pace and only after QE is dialed back to zero would the six months start counting down. Higher rates in the U.S., combined with possible lower Canadian rates, boosted the USD versus the CAD.

There are some analyst that are calling both Mr Poloz and Mrs Yellen's comments "rookie mistakes". It is hard to imagine that after they have served at the respective central banks for so long would they make such mistakes or that they would not foresee that their comments have far reaching implications. The Fed is not stranger to market moving rhetoric, as seen first hand last summer. Then Fed chairman Bernanke announced that tapering had been decided but did not disclose its start date. Emerging markets retreated heavily as this signaled the beginning of a global low rate environment. Bernanke and Fed members spent months convincing the market that they had it all wrong and had overreacted to the announcement. "Tapering is not tightening" was a mantra the Fed pushed all of last year. Did Yellen forget that lesson or is it part of her Fed stewardship to link the end of tapering to rate hikes, as her comments seem to indicate?

The USD has hit four year highs on the back of economic indicators released, as well as central banker comments this week. Canadian fundamentals have looked soft in the past months. The weather has been the main excuse, but even Governor Poloz dismissed the weather as the major culprit. The weaker loonie could be a positive to regain competitive advantage regarding exports. The lower currency has major banks reassessing their forecast for Canadian growth with is now likely to end 2014 at 2.5%

Changes at the Federal level with the Minister of Finance resigning last week had no effect on the price of the currency but could have a political cost in next year's elections.