Axel Merk’s bet against the Canadian dollar, one of the biggest he’s ever taken, had its roots with the appointment of Stephen Poloz as head of the Bank of Canada.
Merk, a foreign-exchange money manager in California, was surprised last May when Finance Minister Jim Flaherty picked Poloz, the former head of the country’s export development agency, ahead of former Senior Deputy Governor Tiff Macklem. He took a short position in late November and after Macklem announced his departure from the central bank last month, Merk ramped up his bet.
“We’re talking about some of the more extreme positions we’ve ever taken,” said Merk, whose Merk Absolute Return Currency Fund was one of only two U.S. foreign-exchange mutual funds to turn a profit last year, according to data compiled by Bloomberg. “We were positive on the loonie a year ago,” he said, adding that view has changed over the past six months.
Merk said he read Poloz’s appointment as a signal the Canadian government wanted a change in the policy set by former governor Mark Carney, which had helped keep the currency close to parity with the U.S. dollar.
Poloz, along with Flaherty and Prime Minister Stephen Harper, have stressed the need to boost exports to encourage growth. The Canadian dollar has lost 7.9 percent against its U.S. counterpart since Poloz took over the central bank in June, reaching the lowest since 2009, ranking it 13th of 16 major currencies tracked by Bloomberg. It weakened 0.4 percent to C$1.1161 per U.S. dollar at 11:06 a.m. in Toronto. One Canadian dollar buys 89.60 U.S. cents.
Investors have built up near-record bets that it will continue to decline. Speculative wagers against the Canadian dollar outnumbered those for the currency by 70,327 contracts on Jan. 21, approaching the record 84,906 net-short positions reached in January 2007, data from the Washington-based Commodity Futures Trading Commission show. A year earlier, futures showed net-long positions of 57,952 contracts.
While some investors and analysts said Poloz’s export background would lead him to promote a weak-dollar policy, “he’s even more of that guy than people expected at the time,” said Jimmy Jean, a strategist in the fixed-income group at Desjardins Capital Markets in Montreal.
Poloz’s appointment came as Harper’s government was increasingly focused on restoring the country’s budget surplus, which meant monetary policy would be more important in fueling growth. Flaherty has stuck with his plan to eliminate Canada’s deficit by the fiscal year beginning April 2015, allowing the government to enact promised tax cuts before next year’s election.
“There is a perception that there is a preference for a weaker currency out of Ottawa,” said Craig Wright, chief economist at Royal Bank of Canada in Toronto. “I don’t know if they are encouraging a softer currency as explicitly as Australia, but there is a perception that they aren’t terribly worried by a weaker currency.”
The bank conducts policy with a goal of bringing inflation to the 2 percent midpoint of a 1 percent to 3 percent range. Statistics Canada said Jan. 24 the average rise in consumer price index was 0.9 percent last year, outside the target band and the slowest since 2009 when Canada was emerging from recession.
Poloz is trying “to bring back some inflation, and we know how inflation is important for government revenue,” Jean said. “We are heading into an election year, and we are looking at a government that is looking to close the deficit, so it’s something that can only help.”
Before Poloz’s appointment, Canadian central bankers were alone in the Group of Seven countries warning of higher interest rates, even with inflation consistently below the central bank’s target.
The dollar was little changed through Poloz’s first four months as the bank hung on to its tightening bias. The decline accelerated in October, when Poloz dropped that wording from the bank’s interest-rate statement.
Jean said that he doesn’t think Poloz is following orders from the government. Poloz told reporters last week he’s not facing any political pressure to weaken the currency. Flaherty told reporters yesterday there’s no government plan to lower the loonie.
“The Canadian dollar is a market currency and it moves in response to market forces,” he said.
While the governor and finance minister traditionally hold regular meetings to discuss economic matters, the bank is allowed to conduct monetary policy independently. If there were a major policy disagreement, the finance minister could issue a directive to the bank, which would probably lead to the governor’s resignation.
After Carney announced in November 2012 that he would become Bank of England governor, Flaherty took the unusual step of issuing a press release that stressed his direct involvement in the process to name a successor. At the time, a majority of economists predicted he would choose Macklem.
“Poloz came in, and then Macklem is now leaving the Bank of Canada entirely,” said Merk, founder and president of Palo Alto, California-based Merk Investments, which manages about $400 million. “The intellectual thought leadership on the hawkish tone is departing from the Bank of Canada.”
The currency’s decline picked up speed in January, as government officials including Flaherty, signaled approval.
“The governor was with us recently with the provincial ministers and he indicated there might be some softening in the dollar,” Flaherty said in an interview broadcast Jan. 5 on CTV’s “Question Period.” “But the dollar in the nineties somewhere is good for manufacturing,” Flaherty said.
Prime Minister Stephen Harper added momentum to the decline with a Jan. 17 Bloomberg interview, saying he approved of Poloz’s policy.
“We have every reason to have confidence that the Bank of Canada has appropriate monetary policies in place,” Harper said. He added what matters is not the movement in the Canadian dollar but whether it’s “at an appropriate level given various economic realities.”
Traditionally, Canadian elected officials avoid commenting on monetary policy issues and the exchange rate.
The dollar’s decline extended last week when the bank issued an interest-rate announcement saying that “stronger U.S. demand, as well as the recent depreciation of the Canadian dollar, should help to boost exports.”
On the same day, the bank published a monetary policy report saying that “despite depreciating in recent months, the Canadian dollar remains strong and will continue to pose competitive challenges for Canada’s non-commodity exports.”
The same document pointed to two government trade initiatives that the bank said will boost output in the future - - the Canada-Europe trade agreement, which hasn’t been implemented, and a plan by the government to use its diplomatic resources more to encourage trade.
Poloz later told reporters that the weaker currency will give an “extra kick” to the economy, and likened it to icing on a cake, with a stronger U.S. economy the main support for exports.
“You need more U.S. demand, first thing. There’s your cake,” Poloz said in a Jan. 22 interview on BNN television. “If that comes out, then we have all the ingredients to bake a cake. But the lower Canadian dollar allows us to put some icing on that cake. That’s the kind of thing which will add to that momentum, but it’s not the main thing.”
Poloz’s willingness to discuss the role of currency movements in promoting growth represents “a fundamental shift from Mark Carney,” Jean said.
“Just the fact the Bank of Canada banks on the weaker dollar to reflate the economy and bring more thrust in net exports, that gives you a suggestion it’s something that’s really welcome,” he said.
Ed Clark, Toronto-Dominion Bank’s Chief Executive Officer, said it may be unwise for policy makers to rely on a cheaper currency to solve economic woes.
“Some recalibration was clearly necessary, but we shouldn’t use it as a permanent solution,” Clark said yesterday during an interview at the Toronto headquarters of Canada’s largest lender by assets. “Countries that solve all their competitive problems by just devaluing generally find in the end that’s not a good way to do it.”
Canada’s dollar isn’t alone in weakening against the U.S. dollar as the Federal Reserve begins to pare its program of stimulating the economy through asset purchases. Since Poloz dropped the bank’s bias statement, the Brazilian real, Australian dollar and South African rand have all fallen further than the Canadian dollar.
Both Poloz, in a December interview, and Harper have cited U.S.-dollar strength for the Canadian currency’s decline. Poloz said anyone running Canada’s central bank would have dropped the bias, given disappointing economic data.
“When you look at the move in the currency we have seen there are a number of factors,” Royal Bank’s Wright said. Weakness is “more reflective of what’s going on in the economy.”
“I don’t know if he’s a weak dollar man,” said Wright, “but the dollar’s been weak while he’s been the man at the bank.”
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