NEWS / Foreign Exchange

USD: the trade balance??™s ???J??? curve is taking a longer than expected detour

Summary

• The most striking characteristic of the greenback bear market of the 1980s was the link between countries??™ current account surpluses and the performance of their currencies. Large current surpluses tended to lead to large currency rises.
• But during the current cycle, changes in some countries??™ current account balances are no longer in line with swings in their currencies.
• In the US, the J1-curve, which usually appears following currency depreciation, is thus taking longer than expected to materialize. Special circumstances in Japan and de facto currency manipulation by China, have delayed an expected shrinking in the US current account deficit as a result of the greenback??™s slide.
• Before the American current account balance can contract significantly, the US will need to save more and Asia will need to spend more.

Weekly indicators

United States ??“Q1 GDP growth was revised downwards from 1.3% to an annualized rate of just 0.6%. Consumption rose by a solid 4.4% during the quarter. Business inventories cut 0.7 percentage points from growth while external trade cut another 0.5. US consumption growth is likely to weaken significantly in Q2, to the 2% range. There were 157K jobs created in May, slightly more than the 132K consensus forecast. Despite the economic slowdown, the unemployment rate has not started to rise because the labor force has also started to grow more slowly.

Canada ??“ The Bank of Canada maintained its overnight rate at 4.25%. However the tone in its press release announcing its move was firmer than expected. This opens the door to monetary policy tightening in the near future. Real GDP grew at an annualized rate of 3.7% during Q1, the best result in six quarters. Consumption expenses increased by 3.9%. Final domestic demand rose by 3.1%. The numbers show that the Canadian economy remains vigorous. For the first time in a year and a half, Canadian GDP grew faster than its speed limit and much faster than the US economy. The solid economic data and the tone in the BoC??™s press release mentioned above, leave open the possibility of a rate hike during the coming months. That said, the central bank needs to act prudently, due to the fact that the rapid rise in the loonie since the start of the year (close to 9%) could hurt the Canadian economy.