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'Much ado about Jack': RBC looks at scenarios for loonie

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Dollar scenarios As the senior currency strategist at RBC Dominion Securities puts it, for the Canadian dollar it's "much ado about Jack."

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In a report today, David Watt runs through scenarios for the loonie depending on the outcome of Monday's election.

His comments come as Jack Layton's New Democratic Party experiences a surge in public opinion polls, though how that translates into seats after election day is far from certain.

This is not to endorse or reject any of the political parties or their platforms, only to report on Mr. Watt's findings, compiled as markets awake to the potential for far greater NDP influence in Ottawa.

"Markets have awoken to the surge in pre-federal election polls of the left-wing NDP," Mr. Watt said in his report.

"If the polls do result in the NDP's seat total rising materially, which is far from a foregone conclusion, [the Canadian dollar]might experience a modest selloff, though such an outcome is not unequivocally clear. The election may well result in more, not less, political uncertainty, which could translate into increased [Canadian dollar]volatility. In fact, there are credible scenarios in which the NDP's surge could prove to be [Canadian dollar]positive."

Here are Mr. Watt's scenarios:

Conservatives win, NDP gains: "If the NDP present an opening toward a Conservative majority, the result may be [Canadian dollar]positive, or neutral, as the Conservatives' policies are well known and they have flirted with the majority threshold through much of the campaign. This would occur if the NDP draw more support from the Liberals, with vote splitting allowing more Conservative candidates to be first past the post."

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Combined Liberal and NDP seats don't reach the magic 155: "This would likely leave a Parliament much like the last one, though with more NDPers and fewer Liberals. The NDP as Official Opposition would generate headlines and could cause [the Canadian dollar]to wobble, but keep the context in mind. The separatist BQ became the official opposition in October, 1993, a dire time for the Canadian economy. Those were the days when Canada was a fiscal sinner, the country looked to be fracturing, Canada's foreign currency rating had been put on watch (Moody's) or cut (S&P) in 1992, and local currency ratings were under increasingly scrutiny ... The contrast with today could hardly be starker."

Combined Liberal and NDP seats at 155 or more: "Abstracting from the potentially constitutionally relevant issues that could unfold, this result would place PM Harper under watch, given the possibility of an alternative government that could garner the confidence of the House of Commons, be it Liberal- or NDP-led. This would likely create the greatest degree of political uncertainty, and boost [Canadian dollar]volatility. The easiest, and likely the incorrect, conclusion would be to consider the result as outright [Canadian dollar]negative, even though the federal government could take a more activist stance. The NDP election platform still projects a four-year deficit-reduction strategy, as Canadians have no desire to revisit the dark days of the early to mid-1990s."

There's another element, too, according to Mr. Watt. Were the governing party or parties to launch into "more expansionary" fiscal policy, tightening policy could then be left to the Bank of Canada. And as long as looser tax policies don't hit a credit rating, that together with tighter monetary policy has often meant strength for a currency.

The Canadian dollar has, of course, been buoyed by a combination of factors, including the sagging U.S.currency, Canada's fiscal and economic outlook, and strong commodity prices.

RIM in profit warning Research In Motion Ltd. is lowering guidance for its fiscal 2012 first-quarter, Globe and Mail technology writer Omar El Akkad reports.

The Waterloo, Ont.-based smartphone maker said late today its diluted earnings per share for the quarter ending May 28, 2011, will be in the range of $1.30 (U.S.) to $1.37. In late March, the company said earnings would be in the range of $1.47 to $1.55.

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RIM blamed the lower guidance on lower-than-expected BlackBerry smartphone shipments, and a shift to lower-priced BlackBerry handsets.

U.S. dollar sinks The U.S. dollar sank today today, dropping to its lowest level in about three years before regaining ground, after the Federal Reserve signalled yesterday it plans no change in monetary policy any time soon.

In turn, currencies such as the Australian dollar and the loonie rose.

The U.S. central bank's policy-setting panel, the Federal Open Market Committee held its benchmark rate at a historic low near zero and suggested no change is planned. As Globe and Mail Washington correspondent Kevin Carmichael reports today, the Fed is putting concerns over high unemployment before the threat of inflation as the United States struggles back from the recession.

"The dollar is under assault and there really is no other way to explain what is taking ... and has been taking … place in the [foreign exchange]market since yesterday afternoon following the FOMC's decision and then worsened following Dr. Bernanke's precedent-setting post-meeting press conference," said Dennis Gartman, publisher of The Gartman Letter.

"Simply put, we came away from the post-meeting communiqué believing that this was a demonstrably dovish commentary by the committee; that the authorities were more than willing to err manifestly upon the side of easier rather than tighter policies, and that the dollar was for all intents the sacrificial lamb that was going to be taken out for slaughter, mincing as few words as we might in this instance."

The strength of the loonie against its U.S. counterpart, said Scotia Capital economists Karen Cordes Woods and Derek Holt, puts the timing of an interest rate hike by the Bank of Canada into question.

"Indeed, while we've long been of the view that the BoC is on hold until October and have been consistently later than consensus as it has shifted from Spring to July hikes, we attach greater tail risk to taking the BoC entirely out of the picture in 2011 than the tail risk of going earlier than our call," they said.

U.S. growth slows U.S. economic growth slowed in the first quarter of the year, fresh numbers show, driving home the points made yesterday by Fed chief Ben Bernanke and hampering America's struggle to climb back from the recession.

Gross domestic product expanded at an annual pace of 1.8 per cent, the U.S. Commerce Department said today, marking a sharp downshift from fourth-quarter growth of 3.1 per cent.

The government report also showed just how surging prices at the gas pump and rising costs for food are hitting American wallets. Consumer spending climbed 2.7 per cent in the first quarter, compared to 4 per cent in the previous three months. Cuts to government spending also hurt.

"The U.S. economy has lost what little upward momentum it had, partly because of temporary factors like bad weather, lower defence spending and auto shutdowns related to Japan's crises, and partly because of not-so transitory factors like rising gasoline prices and state and local budget cuts," said senior economist Sal Guatieri of BMO Nesbitt Burns.

Initial claims for jobless benefits also disappointed markets today, climbing to almost 430,000 and reinforcing the severity of the U.S. jobs crisis.

"The 3.3-per-cent contraction in state and local government spending reflects the ongoing budget problems that will continue to be a drag on the overall economy for some time yet," said chief U.S. economist Paul Ashworth of Capital Economics, pointing out yet another element in the GDP report.

"There is also the prospect of a contraction in federal spending as well now. All things considered, it could have been worse. Nevertheless, in a quarter when the economy began to benefit from additional monetary and fiscal stimulus, we had originally expected a lot more."

An overall cut to government spending, said senior economist James Marple of Toronto-Dominion Bank, was mainly because of a decline of almost 12 per cent in defence spending.

"The main risk to U.S. economic growth at this point comes from rapidly rising energy costs," Mr. Marple said.

"For every 20-per-cent increase in the price of oil, U.S. economic growth is slowed by roughly 0.4 percentage points. Given the over 25-per-cent rise in prices since December, should oil prices remain elevated, this will roughly subtract a total of 0.5 percentage points from growth over the next two years - definitely not enough to push the economy back into recession - but certainly denting the pace of economic recovery and improvement in the labour market."

BMO cites inflation worry Many people appear unfazed by rising inflation. Douglas Porter's not one of them.

In a report today, the deputy chief economist of BMO Nesbitt Burns says rising prices are a challenge for both central bankers and investors. He notes that central bankers "are fond of calmly reassuring one and all that inflation expectations remain well-achored," but inflation itself doesn't appear so.

"The recent surge in oil and food prices has lit a fire under headline inflation globally, with only Japan not grappling with some form of stronger-than-expected price increases," Mr. Porter writes.

"The shockingly large uptick in Canada's March CPI brought this country into the fold, with the powerful loonie seemingly powerless to hold back bigger global price pressures. The pressing question for markets is whether this represents a one-time surge in specific prices, or the leading edge of a wave of rising inflation. The conventional wisdom leans to the former, with other recent energy price run-ups not translating into broader inflation. After all, we had a sneak peek at this movie before - the commodity surge of 2005-08 - but that inflation threat was only cut short by the financial crisis, hardly a happy ending. This threat looks like a more significant inflation challenge for policy makers and ultimately financial markets."

Not that inflation isn't on the Federal Reserve's radar, but it has put other concerns ahead of it in pledging to keep interest rates low for some time yet. The Fed said yesterday it believes the impact of rising energy and food prices on inflation to be "transitory."

"In recent announcements, both the Bank of Canada and the Federal Reserve sounded in absolute zero rush to begin tightening policy, with both viewing the recent rise in headline inflation as transitory," Mr. Porter said.

"Yet, there is a clear danger that policy makers risk suddenly falling behind the inflation curve. By almost any measure ... monetary policy remains exceptionally loose in both the U.S. and Canada. Despite the soothing words from central banks on this point, there is little doubt which way inflation risks are now tilting."

(For a look at global inflation, see the accompanying infographic or click here.)

Record quarter for Potash Potash Corp. of Saskatchewan today posted a record first-quarter profit, which surged to $732-million (U.S.), or 86 cents a share (basic), from $444-million or 50 cents a year earlier. Revenue climbed to $2.2-billion.

Global potash demand neared "record territory" in the three-month period, the company said, as big markets scrambled to meet their near-term needs.

"Tight global grain inventories, strong crop returns and the need to address nutrient deficiencies are powerful motivators for the world's farmers, and the impact was evident in our record first-quarter results," said chief executive officer Bill Doyle.

"Robust demand for all three nutrients demonstrated a global push to improve crop yields and reflected the importance of fertilizer to food production. This is especially true of potash and, as higher prices for our core nutrient continued to take hold, we began to demonstrate the earnings potential of our company."

Many other major companies are also reporting results today.

Bank of Japan outlook weak The Bank of Japan painted a grim outlook for the economy today as it held its policy unchanged, citing the devastation that hit the country last month.

"Substantial supply-side constraints since the earthquake have disrupted the recovery mechanism in which recovery in overseas economies fuels the momentum for recovery in Japan through increases in exports and production," the central bank said in its report.

"The earthquake has led to the loss of a large number of production facilities in widespread areas directly affected by the disaster. In addition, difficulties in procuring materials and parts have disrupted supply chains on a national scale. Power shortages have become another supply-side constraint. As a result, production in some areas has declined sharply, severely affecting exports as well as domestic shipments and sales."

The central bank now projects the economy will expand by just 0.6 per cent in the current fiscal year, compared to its forecast of 1.6 per cent made in January before the earthquake, tsunami and nuclear crisis.

Japan's economic indicators show just how badly the economy was hit in March. Industrial production fell more than 15 per cent, auto output more than 57 per cent and household spending 8.5 per cent.

"It is not that no one was expecting it, but the first comprehensive look at Japan's economic statistics for the period after the March 11 earthquake, tsunami and atomic accident is simply awful," said Carl Weinberg, chief economist at High Frequency Economics.

"It is important to note that any growth will be from a severely depressed level: Japan's economy will remain in a dark hole for a long time," Mr. Weinberg added in a research note.

"Most telling of all is the labour market report. The data indicate 3.2 million fewer people working as of the end of March than the end of February. This is an unprecedented drop in employment in a single month."

In Economy Lab today

World Bank economists warn China's macroeconomic policies still need work to get inflation and a roaring property market under control, Carolynne Wheeler writes.

The tax policy debate for Monday's election pivots on a fundamental mischaracterization peddled by several parties - that corporations are people. Kevin Milligan reports.

In Personal Finance today

Don't assume you don't owe any taxes, says Home Cents blogger Roma Luciw. For those who owe money, dilly-dallying can be a costly mistake.

Know your rights and obligations as the tax deadline approaches, Tim Cestnick writes.

Rob Carrick offers five reasons to think about moving from the Canadian market into international investing.

From today's Report on Business

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About the Author
Report on Business News Editor

Michael Babad is a Report on Business editor and co-author of three business books. He has been with Report on Business for several years, and has also been a reporter and editor at The Toronto Star, The Financial Post and United Press International. His articles have appeared in major newspapers around the world. More

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