How Keystone Pipeline Delay Impacts the Canadian Dollar

• How Keystone Pipeline Delay Impacts the Canadian Dollar
• AUD Steadies Despite Dip in Gold
• NZD Extends Losses Ahead of RBNZ
• Dollar Shrugs Off Rise in Leading Indicators
• Euro On the Move This Week
• GBP: Holding Near 4-Year Highs
• JPY: Deterioration in Trade Expected to be Temporary

How Keystone Pipeline Delay Impacts the Canadian Dollar

Most of the major currencies consolidated against the U.S. dollar today, which is not surprising given that major markets in Europe and Asia were closed for Easter Monday.  Trading will get back to full swing on Tuesday when all markets re-open and we expect an active trading week due to the abundance of non-U.S. data.  Before volatility increases, we want to take the opportunity to discuss one of the major political stories affecting U.S. and Canada.  On Friday, the U.S. government decided to delay the construction of the controversial Keystone XL pipeline.  A departmental review of the pipeline was scheduled to end in May but it has now been delayed until the Nebraska State Supreme Court decides on a case relating to its pipeline sitting law. At this stage, it looks like no decisions will be made until after the November midterm elections. For the U.S., the Keystone pipeline is said to provide jobs, energy security and lower prices but there are significant environmental concerns.  For Canada, the implications of the pipeline are less ambiguous. Oil is Canada's most important export and over the past few years, Western Canada Select oil has traded at a discount as large as $42.50 per barrel to the U.S.' West Texas Intermediate because of transportation limitations.  According to the Canadian Chamber of Commerce, the pipeline and the lack of other transportation measures is costing Canada's economy $50 million a day.  If the pipeline is built, it would expand capacity by 700k barrels per day, increasing Canadian GDP by another $633 billion over the next 25 years.  The latest delay has and should continue to drive down the value of the Canadian dollar.  Although the gains have been slow, USD/CAD has quietly edged higher over the past 8 trading days.  While the muted reaction in USD/CAD to Friday's decision suggests that market participants have come to realize that there won't be a quick decision on the Keystone pipeline, the Canadian dollar should be trading lower. 

The Australian dollar also ended the day unchanged against the greenback but the New Zealand dollar extended its losses. This is a big week for New Zealand with the Reserve Bank poised to raise interest rates for the second time in a row. Unfortunately the RBNZ could make future rate hikes conditional because of the recent decline in milk prices and pullback in CPI growth. By reducing their hawkish bias, the RBNZ could erase any positive reaction to a rate hike.

Dollar Shrugs Off Rise in Leading Indicators

It was an extremely quiet North American trading session with the dollar extending its gains against the Japanese Yen and euro. U.S. stocks also edged higher while 10 year Treasury yields gave back part of Thursday's gains. This is a relatively light week for U.S. data and there are no Federal Reserve officials scheduled to speak ahead of next week's FOMC decision.  Today's report on leading indicators for example had virtually zero impact on the U.S. dollar. Leading indicators rose 0.8% in the month of May, up from 0.5% in February. This latest economic report confirms that the U.S. economy is recovering gradually but none of this week's reports are significant enough to slow or accelerate the central bank's monetary policy plans.  This means we do not expect any consistency in the performance of the greenback.  Instead G10 currency pairs will most likely trade on relative growth and data from other parts of the world.  It will still be important for FX traders to keep an eye on U.S. yields and whether Thursday's gains continue.   

Euro On the Move This Week

With German and French markets closed for Easter Monday, the euro ended the North American trading session slightly lower against the U.S. dollar.  After four days of tight consolidation, this is the first time that we have seen a bit of action in the euro, although the move is still very modest.  While ECB officials will be happy with the recent stability, their comfort should be short lived because the euro will be on the move this week with the flash PMIs and German IFO report scheduled for release.  The top priority for any major central bank is growth and inflation.  Last week, we learned that inflationary conditions in the Eurozone improved and this week we will get more information on activity. If the PMI reports show an improvement, it would ease the need for further easing, lending support to the euro.  However economists are looking of the Eurozone PMI composite to retreat from elevated levels due to the slowing in emerging markets and turmoil in Ukraine and if they are right, the euro could accelerate its losses.   A number of Eurozone officials are also scheduled to speak this week including Mario Draghi and if they continue to stress the possibility of additional stimulus and/or complain about the high level of the currency, EUR/USD could slip to 1.37.

GBP: Holding Near 4-Year Highs

With U.K. markets closed on Monday, the British pound hovered near its 4-year highs against the U.S. dollar throughout the North American trading session.  Although there have seen both upside and downside surprises in U.K. data over the past 2 weeks, many investors and economists still believe that the Bank of England will be the next G7 central bank to raise interest rates. We will get a good sense of whether policymakers have moved closer to raising rates later this week when the Bank of England minutes are released but chances are MPC officials are comfortable with the current level of policy and will not express any immediate desire to tighten unless wage growth accelerates. Nonetheless sterling received a boost today from two fronts - the Center for Economics and Business Research said they expect the U.K. economy to grow at its fastest rate in 7 years in 2014.  According to our colleague Boris Schlossberg, "Another possible reason for pound strength was speculation of a potential bid by Pfizer for UK pharmaceutical giant AstraZeneca. The deal could create a 150B giant, although both companies remain tight lipped about progress in the negotiations. Meanwhile currency traders may be trying to get ahead of the news for the possible M&A flow impact on GBP/USD with potential of possible 50B GBP going into the deal."  No U.K. economic reports are scheduled for release on Tuesday.

JPY: Deterioration in Trade Expected to be Temporary

The Japanese Yen traded lower against all of the major currencies today. Although Japan was one of the few markets open on Easter Monday, there was very little movement in the Nikkei. At the same time, the decline in U.S. Treasury yields today provided no support to USD/JPY.  However considering that USD/JPY barely budged on Thursday despite a 9bp rise in 10 year yields, part of today's move in USD/JPY can still be attributed to a catch-up to yields after the holidays.  The primary catalyst for the sell-off in the Yen was Japanese data. Japan's trade deficit ballooned to Y1.43 trillion in the month of March from -Y802 billion.  Exports grew at a sluggish 1.8% pace while imports surged by 18.1%.  The rise in imports reflects a rush in consumer demand before the consumption tax increase in April.  Therefore, the deterioration in trade is likely to be temporary with imports normalizing this month.  So far it seems that consumer demand has been holding up well since the tax increase. While it is still too early to tell, this validates the Bank of Japan's optimistic outlook and could delay potential easing.