The price of crude oil has continued to plunge overnight with both WTI and Brent falling to new lows on trend again as traders continue to react negatively to yesterday’s comments from the International Energy Agency, who forecast higher supply growth, lower demand growth and an up to 1.5 mmbbl/day oversupply on Iran’s return to the world oil market.
Falling oil prices dragged on world stock markets again overnight. The Hang Seng and Nikkei both fell about 3.75% (ouch) while Shanghai and Shenzen fell only about 1% each. Stabilization of the indices which had led the selloff can be seen as a sign the selloff is close to running its course, but a bottoming process could be bumpy.
US and European indices fell overnight as well but have stabilized at lower levels over the last few hours, suggesting we could be getting close to a selling climax. The Dow, FTSE and DAX are all down between 1.5% and 2.5% so far today. There are a lot of earnings reports this morning which could influence trading along with US inflation and housing data. Traders responded positively to Netflix;s (O:NFLX) strong headline earnings and mixed subscriber growth; today’s results and reaction will give another indication on how far down expectations have come.
Capital coming out of stocks, oil and other risk markets has been finding its way into defensive havens, particularly gold and JPY. Overnight there have been reports that the Bank of Japan is monitoring the currency (ie they are getting concerned about the rally) and could cut their inflation forecast (a way to make JPY less attractive without having to intervene directly).
Sterling, meanwhile, is showing signs of life today, getting a boost from a better than expected UK employment report that showed stronger than expected job growth. This helped to offset some of the negative impact from yesterday’s dovish comments from Bank of Governor Carney about now not being the time for a rate cut.
Oil sensitive currencies have been under pressure again this morning with RUB getting totally smashed, NOK falling moderately and CAD down only slightly indicating Loonie traders are more focused on today’s Bank of Canada meeting.
Today’s Bank of Canada meeting, one where the decision on interest rates appears to be up in the air, has the potential to be a big event for trading today.
With the price of crude oil having fallen from above $40.00 at the time of the last meeting in early December to below $30.00 today, speculation had been growing in recent days that the Bank of Canada could potentially cut interest rates again at this meeting to help prop up the economy. A rate cut is not a sure thing, however, but with the loonie having become so overextended technically lately, whatever decision is reached whatever happens we could see significant trading action on the news as there are likely to be a number of traders who need to scramble to get back on side. .
Those in favour of a cut may point to the potential impact of a lower oil price on the Canadian economy, in particular that it could lead to more layoffs in oil producing regions and that the economy could use a boost from a lower rate. Also, having cut rates in January and July of 2015, some may see the central bank as being due for another cut if it continues that pattern. Some may see Governor Poloz’s comments last month on negative rates as an emergency measure hinting at the potential for additional cuts.
Since the last Bank of Canada meeting, employment has continued to grow and the trade deficit has improved. On the other hand, monthly GDP went negative, housing starts fell and retail sales has been soft. PMI figures also have been weakening with both RBC and Ivey under 50 and falling.
Those in favour of holding may suggest, however, that the Bank of Canada has preferred to use the falling dollar as its main tool for rebalancing the economy, and that the job gains of the last two months indicate that rebalancing is underway. (The negative impact of the oil crash hit sooner, while the benefits of the lower loonie on exports, manufacturing, shopping and travel patterns and other benefits take longer to emerge). The loonie is down 17% from a year ago and 12% from 6 months ago already, how much more stimulus would a quarter point cut really add compared with the currency decline?
There are some negatives to a lower loonie, such as higher prices for imported food which can impact consumer spending and as we saw in the 1990s, the loonie could eventually reach a point where the Bank of Canada’s ability to cut rates further could be limited. Concerns about what lower rates could do to red hot housing markets in some cities may also keep the Bank on hold. A cut could also be seen as a vote of non-confidence in the economy and could raise questions about how bad things are out there.
I don't like sitting on the fence but I really think there’s a 50-50 chance of a rate cut with strong cases for both sides. I do think Governor Poloz will use the statement to try to manage the reaction. If the bank cuts rates, we will likely get a neutral statement suggesting it’s going back on hold for now, if the bank holds rates we will likely get a dovish statement leaving the door open to a future cut.
I also think that the decline in the loonie over the last few weeks has more than priced in a rate cut. Because of this, just as the USD had fully priced in last month’s rate hike so it didn’t go up much afterward, I think CAD has fully priced in a rate cut so it may not fall much further if one happens. If the bank doesn’t cut rates, we could see a big snap back rally with CAD so oversold technically. In other words, no matter what happens tomorrow, CAD may continue to carve out a bottom while remaining sensitive to swings in the oil prices.