Larry Berman

Berman's Call

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Janet Yellen will spin her Fedspeak on Aug. 26 at the annual Jackson Hole conference. There has been a gaggle of Federal Open Market Committee (FOMC) members opine that the market is not properly pricing the risk of a rate hike this year. The market reaction last week after the July FOMC meeting minutes seemed to suggest no rate hikes were likely this year. The latest and most influential to opine is the Fed’s Vice Chairman Stanley Fischer. He suggested that the Fed’s economic goals are close to being met. The odds of a rate hike at the September meeting are only 26 per cent, but that is up from 22 per cent on Friday before Fischer’s comments. Odds of a December rate hike are now 54 per cent.

Market pundits often suggest that the Fed does not want to interfere with the U.S. election so they would look to wait until after Nov. 8 to move rates. History actually refutes that notion. They have moved rates in both directions in front of an election. In 2008, they cut rates twice in October in the wake of the post-Lehman volatility. They also tightened rates a few times in the months before the 2004 election.

Wages are rising and global markets are strong right now – these are two factors that have kept the Fed on the sidelines in the past. While inflation is lower than their 2 per cent desired target, so too is GDP lower than they would like to see. Truth be told, they will never likely get the perfect Goldilocks opportunity in this macroeconomic backdrop—there will always be something they could find to stay on the sidelines.

A Fed rate hike should strengthen the U.S. Dollar versus most currencies and that should have a negative impact on commodity prices—at least that has been the historical correlation. With the seasonal trend for WTI inventories looking bad for prices for the rest of the year, this should be a headwind for the Canadian dollar.

Other political risks around October include the Italian referendum that could see a change of government to the anti-EU Five Star Movement by 2018. This could be very destabilizing for the EU and compound the Brexit risks causing a further strengthening of the U.S. dollar. 

With equity valuations poor and market risks high, one of my top positions right now is being long the U.S. dollar. One of the best positions for Canadians over the next few months is sitting in a U.S. money market ETF like SHV.N or PSU-U.T with the Canadian dollar at 78 cents. One caution: if you pay 2 per cent to buy and sell your foreign currencies, the transaction costs will wipeout most of the potential profit. If you are up for a little more risk with no direct FX costs, than buying ZPW.T gives you exposure to the U.S. dollar and a 7 per cent yield, though you are exposed a bit to falling U.S. equities.

The most likely scenario for the next few months is that the combination of a pending U.S. rate hike and the likelihood of crude oil falling back to $35 as inventories build after the summer driving season pushes the Canadian dollar 4 to 5 per cent lower toward 73 cents some time in Q4. Whether it is September or December, the bias for the U.S. to raise rates should remain and the bias for a weaker Canadian dollar should persist into 2017. For the Snowbirds looking to go south in the colder months, now would be a good time to buy U.S. dollars for your trip.

I have positions in ZPW.T and the U.S. dollar for clients.