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The Canadian dollar and other commodity currencies, which have outperformed since the financial crisis, are now overvalued and look ripe for a pullback, says a new report from Barclays Capital Markets. The only question is when.
"The traffic light has changed from green to amber for the commodity currencies," said Paul Robinson, a currency analyst at the Londonbased bank. "It is too early to expect rapid depreciation, but we do not expect further appreciation over the next three months."
According to Mr. Robinson's estimates of purchasing power parity, a measure of relative inflation differentials, the Canadian dollar is 17% overvalued relative to the U.S. dollar, while the New Zealand dollar is 26% overvalued and the Australian dollar is 33% too expensive.
He thinks all three currencies are likely to start depreciating in the second half of this year and the risks are generally to the downside.
Those risks include a quicker slowdown than expected for Chinese growth, negative oil supply shocks, which are bad for the Australian and New Zealand dollars but not the loonie, and an increase in risk aversion, due to the incredible rally in equities.
In addition, Mr. Robinson thinks commodity cur rencies are susceptible to the possibility that G4 nations, in particular the United States, could move quicker than expected on tightening monetary policy.
"We strongly believe that [loose monetary policy], together with questionable fundamentals in all of them, has had a significant effect on the commodity currencies," the analyst wrote.
"The G4 economies' fundamentals are slowly being addressed and while monetary policy is not suddenly going to become tight, it is likely to tighten, either through central bank policy in Europe or robust growth leading to higher market yields in the U.S."
Since the recovery from the financial crisis began in March 9, 2009, the Canadian dollar has risen 31% against the U.S. dollar, the Australian dollar has appreciated 59% and New Zealand's dollar is up almost 50%.
Mr. Robinson said increases in all three currencies are due to strong commodity prices, good economic fundamentals and tighter monetary policy by Australia and New Zealand in particular.
In addition, he said G10 commodity currencies may have benefited from emerging market nations actively limiting the appreciation of their real exchange rates in the face of tighter monetary policy and global capital seeking relatively strong returns.
George Vasic, a UBS strategist, said the Canadian dollar has benefited mostly from the rise in commodity prices and very little if at all from its sound fundamentals and monetary policy that remains relatively loose despite three rate hikes in 2010.
He said in a note to clients that there is a 0.95 correlation between commodities and the loonie since 1995. Based on UBS's long-run forecast for oil at US$92 a barrel, gas at US$5.50 per million British thermal units and gold at US$1,150 an ounce, he said the Canadian dollar will likely decline to parity in 2011 and fall to US95¢ in 2012 and US90¢ by 2015. The loonie settled at US$1.0240 on Monday.
"An important implication of the tight linkage between commodities and the CAD is that the usual currency fundamentals, such as economic conditions and monetary/fiscal policy, don't actually mean that much for the currency," he said.
"And neither does purchasing power parity. This is underscored by the fact that PPP was at a similar level between 1998 and 2003, when the Canadian dollar traded around US65¢ . and when commodity prices were depressed."
Article provided by writer: David Pett, Financial Post
http://www.financialpost.com/news/Loonie+looks+ripe+pullback+economists/4518919/story.html
" Post-crisis, bank risk on rise again "..
" if we want a better outcome, supervisors and business leaders had better do something different this time around " ...
A term as emblematic of the heady pre-financial crisis days as “covenant-light” is not something one expects to hear these days from a high-ranking official at Canada’s top financial watchdog.
But that’s exactly the term used on Sunday by Ted Price, assistant superintendent at the Office of the Superintendent of Financial Institutions, to justify a push for more action by regulators even as a recovery appears in flight.
Covenant-light, which refers to lending with few strings attached and therefore more risk, is one that has been mumbled darkly in recent private gatherings of business heavyweights. In these circumstances, executives will acknowledge that less than three years after the worst financial meltdown since the Great Depression, risk has been repriced yet again — and back to the levels before the crisis set in.
In some cases, they say, the strategy is being employed to push off the inevitable — a non-payment of debt — while ensuring that minimum monthly payments continue to trickle in for as long as possible.
Peter Nerby, a senior vice-president at Moody’s who is responsible for the ratings of Canadian financial institutions, said he is worried about the apparent relaxation of loan agreements and the appearance of increased risk-taking at some North American financial institutions.
“It absolutely is making a comeback,” said Mr. Nerby, who is based in New York, adding it is “appropriate” for the regulator to draw attention to such behaviour.
While Mr. Nerby said it would be an “extreme case” where covenants are so light that a default is virtually impossible to be triggered, even anecdotes of such cases are a chilling reminder of an infamous pre-crisis statement by Citigroup chief executive Chuck Prince. In 2007, just before the liquidity dried up and forced markets around the world into turmoil, Mr. Price said his job as head of one of the world’s biggest financial institutions was to continue to dance as long as the music continued to play.
In a speech delivered Sunday at the Latin America Economic Forum in Calgary, OSFI’s Mr. Price likened the phenomenon of increasing competition, diminishing returns and increased risk appetite to a replay of a bad movie. And he urged more regulatory intervention because, he said, the unhappy ending will not miraculously change without some purposeful editing.
The repeating cycle has brought back other pre-crisis instruments such as structured derivatives, this time based on volatile commodities, he said.
“If we want a better outcome, supervisors and business leaders had better do something different this time around,” Mr. Price warned.
He did not restrict his warnings to the behaviour of bankers and their regulatory supervisors. Indeed, his comments extended into the boardrooms of financial institutions.
“Boards need to ensure that effective risk management is truly part of their business culture,” Mr. Price said. “Businesses that take the lead in improving their risk management systems will be better prepared for the next phase in the cycle, when those around them are acting out of fear.”
OSFI officials on Monday declined to elaborate on Mr. Price’s comments.
Banking analysts said it is difficult to envision what specific regulatory interventions could be put in place to control the behaviour Mr. Price highlights.
“As Mr. Price suggests, the vicissitudes of risk appetite are very difficult to contain - being tied, as they are, to human nature,” said Peter Routledge, who tracks Canada’s banks at National Bank Financial. Among the challenges for regulators, he said, will be to pinpoint the primary sources of the increased risk appetite.
“Given the much intensified scrutiny of, and restrictions on, regulated financial institutions, one might be more likely to find excessive risk appetites outside of regulated financial institutions,” Mr. Routledge said. “That is not to say regulators should decrease their scrutiny of the regulated sector, but that they may have to increase their scrutiny of sectors or players not presently under the regulatory umbrella.”
Article provided by writer: Barbara Shecter, Financial Post
http://www.financialpost.com/news/financials/Post+crisis+bank+risk+rise+again/4517378/story.html
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