As 2015 got underway, the Bank of Canada surprised the entire world by announcing a 0.25% rate cut in mid-January. This came completely from left field and markets don’t like dramatic policy changes. The Bank of Canada cited the unprecedented oil price collapse that took place at the end of last year as the primary reason for the change in monetary policy and characterised the rate cut as an “insurance” to help the economy weather the oil price shock. But it seemed like a desperate move and it had the intended consequence of driving the Canadian dollar lower.

 

I went to hear Governor Poloz’s inaugural speech in Oakville almost 2 summers ago and as I listened I concluded that he definitely wanted a lower Canadian dollar to help the Canadian export market. Coming from the Export Development Corporation, he knows first-hand how a low currency helps with exports and it seemed to me that the loonie was consistently “talked down” from the mid $0.90s where it was when he came into office. Then the rate cut pushed it towards $0.80 and then the markets took it even lower.

 

Across the pond, Europe finally launched its own version of Quantitative Easing earlier this year and with European bond yields already extremely low, there is no doubt that the principle reason for this activity was to pressure the Euro lower. Currency markets obliged and the Euro dropped from about 1.18 (against the USD) at the start of the year to a low of about 1.05 by mid-March.

 

Since currencies are “relative” to each other, the USD has continued to strengthen in this environment (remember the Federal Reserve is no longer printing “new” money at the moment). And while the USA seems okay with the recent strength in their dollar, American multinational companies are starting to squeal as a strong dollar impacts their abilities to sell more abroad.

 

Since the Financial Crisis, I have talked about currency wars and we are witnessing them heating up. The USA does not want a rapidly escalating currency and while the Federal Reserve is desperate to begin to “normalize” borrowing costs (as in more than 0%), raising their interest rates in isolation will drive their currency higher still and jeopardize their economic recovery. So while everyone is expecting the USA to follow through and begin raising interest rates later this year, anything more than a “token” 1 or 2 small increases is unlikely. After 6 years of emergency monetary policy it is hard to justify 0% interest rates any longer. But it will be very hard to do when the whole world is lowering rates and devaluing their currencies.

 

All of this excess liquidity that is sloshing around the financial markets has driven up asset prices in some cases to excessive valuations (real estate, biotech, etc.). I continue to be somewhat defensive and prefer to sip (not gulp) the Kool-Aid. The Rule of Unintended Consequences will likely make an appearance at some point.