July Currency Matters .pdf

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Currency Thoughts
July 2015
Paul Lennox, CFA, President EncoreFX
These are my observations regarding the US and Canadian dollars as of June 30 th. This report is for informational
purposes only and does not construe investment advice.

Long-term Perspective
Currency markets often move in 4-6 year trends reflecting underlying economic dynamics so it is
important to understand the big picture…

After more than a decade of devaluation the US dollar is back in favour. The dollar started its decline at
the turn of the century as the Federal Reserve lowered interest rates dramatically to limit the fallout
from the .com and NASDAQ bubble bursting in 2000. 9/11 leading the US to war and a sharp rise in US
government spending put further pressure on the dollar. The global credit crisis in 2008 and the PIIGS
crisis in 2010 caused the dollar to rally on a flight to safety play. The aggressive monetary easing by the

Federal Reserve through to mid-2014 kept the dollar contained in spite of signs of growing global
economic risks.
The US Federal Reserve remains extremely dovish, otherwise the US dollar would likely be much higher
given the state of the global economy. The liquidity provided by the Federal Reserve for almost 15 years
has flooded into emerging markets, stocks, commodities and real estate. With the Fed turning off the
liquidity taps and US interest rates on the rise companies and investors who have borrowed cheap
dollars are vulnerable and may have to scramble to cover their short dollar positions. This rush for
dollars caused the massive appreciation in the dollar in the 1980’s.
At this stage we do not know if the 20% gain in the dollar over the past year is the beginning of another
secular bull run in the dollar like we saw in the eighties but we can’t rule it out. Despite all of its
challenges the US economy is in relatively better shape than most others and the US could outperform
for years to come. Weak commodity prices as seen in the following charts for the CRB index and copper
are reflective of a weak global economy.
Copper prices down 42% over past 3 years…

Falling commodity prices reflect a weak global economy…
Weekly .TRJCRB

26/03/2010 - 24/07/2015 (NYC)

BarOHLC, .TRJCRB, 03/07/2015, 223.1196, 224.7078, 223.0840, 223.5840, -1.2957, (-0.58%)
Price
USD
360

CRB Index

350
340
330
320
310
300
290
280
270
260
250
240
230
223.5840
220
210
Auto

RSI, .TRJCRB, 03/07/2015, 41.661
Value
USD
41.661
40
Auto
Q2

Q3
Q4
2010

Q1

Q2

Q3
2011

Q4

Q1

Q2

Q3
2012

Q4

Q1

Q2

Q3
2013

Q4

Q1

Q2

Q3
2014

Q4

Q1

Q2
2015

Q3

Why does slow global economic growth favour the US dollar? For one thing, trade makes up a smaller
portion of the US economy than it does for many other countries so the US is less reliant on foreign
buyers of its economic output. And because the US economy is outperforming, capital flows to the US
because of more attractive investment opportunities and rising bond yields. Also, commodities are
generally priced in USD so the US economy benefits more from falling commodity prices than other
countries whose currencies are falling relative to the US dollar. This dynamic becomes a positive
feedback loop causing commodity prices to fall and the US dollar to rise much more than expected as
we saw in the 1980’s when the dollar index rose over 100%.
The biggest risk to the bullish dollar outlook is the US Federal Reserve which is very dovish and will not
look favourably on a persistently rising dollar. If the US economy does continue to outperform, however,
the best the Fed will be able to do over the coming years is to slow the dollar down, not prevent its
inevitable appreciation. Odds favour a strong and likely strengthening US dollar for the foreseeable
future. However, as we saw recently, there will be USD retracements and corrections for dollar buys to
take advantage of.

USDCAD
The Canadian economy is in a tough spot relative to the US economy. Debt levels are higher in Canada,
export prices are falling and productivity is lower. Manufacturing has a hard time competing with the US
and Mexico since NAFTA so Ontario and Quebec are not yet seeing significant gains from the 20% fall in
the Canadian dollar over the past year. The Canadian economy actually shrank in Q1 and Q2 is not
looking much better.
The Canadian dollar is following commodity prices lower in an environment of slow global growth…
Weekly CADUSD=R, .TRJCRB
20/07/2012 - 10/07/2015 (GMT)
Price BarOHLC, CADUSD=R, 03/07/2015, 0.8102, 0.8126, 0.8054, 0.8075, -0.0038, (-0.47%), Line, .TRJCRB, 03/07/2015, 224.2842,
Price
USD -0.5956, (-0.26%)
USD
1.03

315

1.02

CADUSD

310

1.01

305

1

300

0.99

295

0.98
0.97

290

0.96

285

0.95

280

0.94

275

0.93

270

0.92
0.91

265

0.9

260

0.89

255

0.88

250

0.87

245

0.86

240

0.85
0.84

CRB

235

0.83

230

0.82

225
224.2842
220

0.81
0.8075
0.8

215

0.79

Auto

Auto
A
S O N D
Q3 12
Q4 12

J

F M
Q1 13

A

M J
Q2 13

J

A S O N D
Q3 13
Q4 13

J

F M A M J
Q1 14
Q2 14

J

A S O N D
Q3 14
Q4 14

J

F M
Q1 15

A M
J
Q2 15

J

Because economic growth is stronger in the US, US interest rates are rising relative to Canadian rates
and this favours the US dollar…
Weekly CAD=, US2YT=RR, CA2YT=RR
Value BarOHLC, CAD=, Bid, 03/07/2015, 1.2341, 1.2412, 1.2302, 1.2376, +0.0060, (+0.49%),
0.25 Spread, US2YT=RR, Bid Yield(Last), CA2YT=RR, Bid Yield(Last), 1.0, 1.0, 03/07/2015, 0.0746

06/12/2013 - 31/07/2015 (GMT)
Price
/USD
1.28

0.2

1.27

0.15

1.26

0.1
0.0746
0.05

1.25
1.24
1.2376

Weekly USDCAD

0

1.23

-0.05

1.22

-0.1

1.21

-0.15

1.2
1.19

-0.2

1.18

-0.25

1.17

-0.3

1.16

-0.35

1.15

-0.4

1.14

-0.45

1.13

-0.5

1.12

USDCAD 2Y IRD

-0.55

1.11

-0.6

1.1

-0.65

1.09

-0.7

1.08
1.07

-0.75

1.06
Auto

Auto
Dec Jan
Q4 13

Feb Mar
Q1 2014

Apr

May
Jun
Q2 2014

Jul

Aug
Sep
Q3 2014

Oct

Nov Dec
Q4 2014

Jan

Feb Mar
Q1 2015

Apr

May
Jun
Q2 2015

Jul
Q3 15

If the capital markets become unsettled because of fallout from Greece or other high risk events, US
interest rates could fall and the dollar rise in a flight to safety play. There is not always a positive
correlation between interest rate differentials and exchange rates; it depends on why interest rates are
rising or falling.

Stock prices in Canada are looking vulnerable meaning Canada may be less attractive to foreign
investors…
Weekly [.GSPTSE List 1 of 250] .GSPTSE

23/12/2011 - 31/07/2015 (TOR)

BarOHLC, .GSPTSE, 03/07/2015, 14,738.48, 14,738.48, 14,511.33, 14,514.78, -293.31, (-1.98%)
Price
CAD
15,300
15,000
14,700
14,514.78
14,400

Weekly TSX

14,100
13,800
13,500
13,200
12,900
12,600
12,300
12,000
11,700
11,400
Auto

RSI, .GSPTSE, 03/07/2015, 41.149
Value
CAD
41.149
40
Auto

J

F M A M J
J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J
Q1 12
Q2 12
Q3 12
Q4 12
Q1 13
Q2 13
Q3 13
Q4 13
Q1 14
Q2 14
Q3 14
Q4 14
Q1 15
Q2 15

The US dollar has gained more than 25% relative to the Canadian dollar over the past few years. There is
serious resistance for the dollar around 1.28, an area that last held in 2009 during the credit crisis. Keep
in mind, however, that the 2009 dollar spike was a flight to safety play in a panicked market so it was
not sustainable and the US Federal Reserve came in and flooded the market with dollars. This time, the
dollar appreciation is due to US economic outperformance so it is more constructive and sustainable.
And the consolidation we’ve seen over the past few months looks like base building for another push
higher rather than a technical breakdown. Dollar momentum remains strong. Expectations are we will
see the US dollar at 1.35 before we see 1.15 again.

Risk
Let’s consider at a few charts we routinely look at for clues to potential currency developments.
Spanish bond yields are showing signs of market nervousness. With the turmoil in Greece the biggest
concern is the risk of contagion to other European countries and beyond. Global central banks have
done a good job protecting creditors from loan losses so governments have been able to borrow very
cheaply. If the investment community loses confidence in the ability of the central banks to continue to
protect them risk premiums and interest rates will rise sharply. Pick your country but keep an eye on
high risk debt for signs of a renewed flight to safety move which will favour the US dollar.
Weekly ES2YT=RR

06/09/2013 - 31/07/2015 (GMT)
Yield
2

BarOHLC, ES2YT=RR, Bid Yield, 03/07/2015, 0.387, 0.490, 0.335, 0.470

1.9
1.8
1.7
1.6
1.5
1.4
1.3
1.2

Weekly Spanish 2Y Bond

1.1
1
0.9
0.8
0.7
0.6
0.5
0.470
0.4
0.3
0.2
0.1
Auto

Sep Oct
Q3 13

Nov
Dec
Q4 2013

Jan

Feb Mar
Q1 2014

Apr

May
Jun
Q2 2014

Jul

Aug
Sep
Q3 2014

Oct

Nov Dec
Q4 2014

Jan

Feb Mar
Q1 2015

Apr

May
Jun
Q2 2015

Jul
Q3 15

Chinese shares have been on a tear once again, doubling over the past year in spite of a slowing
economy. A stock market correction in China could spill over into other global equity markets potentially
leading to a flight to USD safety.
Weekly [.SSEC List 1 of 1126] .SSEC

04/05/2012 - 18/09/2015 (SHA)

BarOHLC, .SSEC, 03/07/2015, 4,289.77130, 4,297.47470, 3,875.04990, 4,053.03040, -138.01660, (-3.29%)
Log
CNY
4,800
4,500
4,200
4,053.03040
3,900

Weekly Shanghai Stock Index

3,600
3,300

3,000

2,700

2,400

2,100

Auto
RSI, .SSEC, 03/07/2015, 52.337
Value
CNY
60
52.337
30
Auto
M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S
Q2 12 Q3 12
Q4 12
Q1 13
Q2 13
Q3 13
Q4 13
Q1 14
Q2 14
Q3 14
Q4 14
Q1 15
Q2 15 Q3 15


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