Tuesday, April 24, 2012

Dude - where's my current account surplus?

Well, today is a very important day for markets, as the largest religion company in the World reports earnings. Despite the strength of the earnings season so far, names have found themselves lower just a couple of days later as profit taking has come in. In the short term, that seems reasonable, but does not detract from the trend that the economy looks pretty good with companies making money - that seems pretty "normal" to TMM. Of course, against that, it seems that everyone TMM speak to expect AAPL to sell off post earnings, regardless of the actual top or bottom lines. Make of that what you will. TMM will most definitely NOT be watching the AAPL release, and will instead be getting pissed down the pub.

Anyway, we digress. In amongst the usual bollox arriving in their inboxes this morning about Europe and concern that a certain Shampoo brand (how do we know the girl in JAWS had dandruff?) was going to portent the end of the world , TMM were asked why, despite Oil prices having rebounded from their recessionary depths, Canada was running a Current Account deficit of close to 3%. Given we're fed up to the eyeballs of anything Europe, we thought we'd have a look.

It's kind of interesting actually, that this particular subject has been brought up given that on that long list of supposedly great macro trades that has so far refused to perform is that old chestnut "Short AUD/CAD". Now please forgive TMM for their snarkiness but, in our opinion, this is one of those trades dreamed up by a group of punters we shall now term as the "Off The Cuff Macro Numpties". This particular group are known for their use of a little knowledge, a few good charts and their favourite hobby "Bubble Hunting", which essentially consists of looking for something that has increased in price by 10-20% and yelling "Bubble!". Oh yes, and telling TMM that we are clueless in the comments section below.

But back to Canada. Looking at the Trade Balance (see chart below), indexed such that Q4 2006 equals 1, it is interesting to note that while post-crisis, both import growth and export growth don't actually look that different, the level of exports fell far more sharply and has not really recovered particularly well. Well, to TMM that exports have not recovered tremendously is not that much of a surprise given that the US recovery (Canada's largest trading partner) has so far been rather tepid. That imports have re-accelerated is perhaps more interesting, particularly in the light of the strength of retail sales in Canada since the recovery began.

Now TMM are unconvinced, as discussed before, by the idea that there exists a housing bubble in either Australia or in the UK. This is primarily because of the balance between housing construction, housing supply and household formation. It is not obvious to TMM that valuations are out of line when the above conditions are either in balance or in deficit (not enough housing supply) when many can be explained by structural falls in interest rates (and interest rate volatility) amongst other things. A full discussion of this is well beyond today's post, but TMM do think that these factors are significant in explain why the US and Spain experienced a spectacular crash in house prices, whereas the UK and Australia (at least so far), have not, despite - well, specifically in the case of the UK rather than Oz - very similar macro outcomes and policy responses.

So why do we bring this up? Because TMM do actually reckon that Canada *may* be a candidate for a housing bubble, given the dramatic run up in house prices, interest rates have arguably been kept too loose post-crisis (understandably so, given the external risks), TMM have received plenty of anecdotes and adverts that evoke déjà vu of 2005 in the US. But most importantly, housing construction has been widespread, it is a big country with not too large a population and housing starts (~215k) have been running above household formation (~170k) for a few years now. TMM haven't looked in enough detail to come to any firm conclusions as to whether Canada's housing boom is a bubble or not, they do reckon that it is different enough from Australia's to matter.

So Canada has clearly had something of a consumption and investment boom. What about Australia? The trade dynamics in Australia look almost the mirror image of Canada's, with imports having recovered to around the pre-crisis, while exports (to China in particular) have roofed it So is this perhaps a case of the real trade *not* actually being a case of long commodity currencies etc, but a case of being long the stuff that people actually want. Because the above evidence suggests that there isn't, y'know, that much demand for Canadian oil and other stuffs.

But that's not the end of the differences. A little observed portion of the Current Account balance is the Current Transfers balance, usually confined to those of us bean-counting remittance flows to Mexico or the Philippines. And it is notable for two similar sized economies that over the past few years that Canada has built up a sizable transfers deficit (white line, chart below) while Australia hasn't (orange line). Now that could mean one of many things, but the most likely explanation is US construction workers having found work in Canada's tight labour market sending their earnings back home.

So given all the above, it would appear to TMM that perhaps the confidence with which punters keep trying to sell AUD/CAD may be misplaced. Because it appears to us that Australia is selling stuff people want, while not experiencing a domestic consumption boom, while Canada appears to be precisely the opposite. Canada also appears a more legitimate prospect (though this is far from certain) for a housing bubble than Australia, and increasingly, migrant labourers are sending their earnings home adding an additional headwind to the currency. Combine that with the popularity of the short, the rather tepid response to the soft CPI print over night, a market now looking for a 50bp RBA rate cut next week (after famous idiot well-followed Aussie Journo McCrann has started predicting it) and a soothsayer "Buy" signal on Friday, and TMM reckon it could be time to squeeze some gonads and scoop up some AUD/CAD.


redrut said...

A very interesting point re the property bubble.... it seems anywhere with an abundance of habitable land was primed for a property bubble over the last 30 years and Canada would not be an exception to the rule.

Moving on, I also am a fan of the short AUD trade but am a little bit confused as to why you would pitch it against the CAD. Yes the CAD is a 'commodity currency' but the commodities it exports (as you said) are completely different while the end users (which you also said) are also completely different. Australia supplies the far East (woohoo) while Canada supplies the US (aww man!)....

The reasoning behind my dislike of the AUD rests squarely behind China's rebalancing economy. And I would use the trade balance data as opposed to the BoP stuff as it is monthly (as opposed to the latter's quarterly bulletin)

Good post!


globalmacrotrading said...

well done.

Next question - what will eventually cause AUDCAD to revert to PPP levels? The last time the current account differentials have been this wide was in the early 90's. The eventual reversion appears to have occurred following a 20% drop in AUD's ToT. Maybe we get a replay of that, potentially following a China rebalance. Whatever the explanation, it does look too early to play this.

Anonymous said...

am i reading your analysis completely wrong or are the trade charts in wrong order? (canada's chart should be the 2nd while the first one refers to aud)?

Anonymous said...

AUDCAD is 6% LOWER since mid feb. Looks like a winning short to me!!

Anonymous said...

Living here in Vancouver, I can assure you that there is a bubble or perhaps a tree expected to grow to the heavens. The housing bubble argument for Canada is based on a few jurisdictions and Vancouver is the epicenter but not the norm elsewhere. Where else can you live in a million dollar condo and hear the kid upstairs dropping stuff on the floor? (we are renters) this place at half a mill would be a stretch.

I would also add that the number of new bmws ferarris lambos mercedes and bentleys has exploded in the last several months as newly minted Asian residents load up before racing said cars on local roads (Aston towed for doing 265 kmh on a local highway last week).

Don't forget to look at government assistance in Canada and Australia. Bubbles always have government support.

cpmppi said...


Thanks. Yes, I think that may be what eventually happens, but given China has a good deal more infrastructure to build over the coming decade (not to mention what appears to be currency diversification in the form of stockpiling itself), it may take a very long time for this ToT fall to occur.

So I agree - too early to play the the AUD/CAD short.

cpmppi said...

Anon @ 3.45pm,

Sorry? So because it has fallen 6% it continues to be a good short?

cpmppi said...

Anon @ 3.45pm from Vancouver,

Thanks. So it does look as though there has not only been an investment boom but also a consumption one. And interesting comment about Asian residents - perhaps this relates to the Current Transfers deficit too...

cpmppi said...

Anon @ 3.41pm,

Thanks - well spotted! I've fixed this now.

Anonymous said...

and to add further research to the argument: http://www.economist.com/node/21551486
the price-to-rent ratio suggests Canada's house prices are 76% overvalued - the highest one in the table.
maybe the reason Carney has been sounding hawkish and rate hikes are on the horizon?

Lykean Capital said...

There are other reasons to be long AUDCAD.. since CAD rates are effectively zero, it has as much carry as AUDJPY/AUDUSD but is far less volatile, as AUD/CAD are both risk on.

There are other plays in it as well... iron ore/coal vs high cost oil, and Chinese growth vs US

Leftback said...

Agree with the post, very well written.

It comes down to demand for copper and coal (AUD to China) versus oil and lumber (CAD to US). With the US awash in crude and clearly making much better progress towards increasing domestic energy production and reducing consumption than China, it's not looking all that rosy for our friends in the Great White North.

Both countries have gigantic housing bubbles, btw, based on affordability metrics and household formation versus construction stats. As noted, the banks and the governments participated fully and will reap the usual harvest. Frozen housing market, MBS crises, foreclosures, bailouts, printing and government debt problems. We can all write the script for this by now. Avoid these banks.

Leftback said...

Going back to Europe for a second, a nice entertaining fairy tale on the pink blog today. It is Italy bashing day this time.

Once Upon a Time

redrut said...


A high price to rent ratio is indicative of expected capital gains....

Why else do you think a Chelsea flat yields 2% and a Dalston flat yields 8%


Charles Butler said...

Started yesterday (revelation being prohibited on all days that are not Monday), LB, when it was decided that the banks had enough to save the kingdom, but not the republic.

Arithmetic - a skill with a future.

Leftback said...

Thanks to Señor Butler for his local knowledge and this is probably what Charles is referring to. A nice explanation of why Spain probably isn't detaching from the mainland, at least not in 2012:

Funding Spain

As Charles points out, this is supported by actual data and some grade school arithmetic, showing that, you know, Spain might actually have enough money to support their own debt. It turns out that analysis of sovereign debt is, you know, facilitated a bit by actually looking at how much debt is being issued.

Now when you look at Italy, on the other hand, it's decidedly more dodgy....

Isaac Newton said...

AAPL is falling.

Polemic said...

Nice tag Isaac !

Bob Dobalina said...

Ctrl-F gas *not found*

Dunno if it's big enough to explain the current account dynamics of the Great White North but at the very least it needs to be ruled out, no?

Anonymous said...

Re: Uk property. God forbid that one should take one single transaction as representing a market but this is settled bungalow estate in Worthing and this is the latest and best offer on a 3-bed spick and span bungalow that only last summer was selling for £320,00. The bungalow of the seller in question as been on the market since last November. His best offer this week is £260,000. If that is not a market in retreat I don't know what is. Perhaps something is just starting to happen?

abee crombie said...

a bit off topic, but AAPL is a machine. regardless of what price does tom, this company is just killing it. Wow!

Anonymous said...

Canada is too big to generalize a housing bubble. Too many different economies across 10 different provinces. What might be true in Vancouver, thanks to Asian investment is not at all a reality in the rest of the country...check out the Maritimes for affordable housing

Anonymous said...

Guys, guys, guys. You're totally missing the picture here! Now that the Canadian glow in the dark quarter with a dinosaur motive has hit the markets, the whole world is gonna wanna get their hands on 'em. Things are going to change, drastically! I've been saving up for seconds already. My quick estimation tells me that this is going to move markets.


Anonymous said...

'cpmppi said...
Anon @ 3.45pm,

Sorry? So because it has fallen 6% it continues to be a good short?'

Well, it is if you have had the trade on from those levels, yes!

And at the moment the trade makes a lot of sense.

One central bank fighting a two speed economy, in which rate cuts are becoming a blunt tool due to contiuned currency strength and domestic banks not passing on rate cuts.

The other fighting a potential credit and housing bubble with rates far too low than where they should be.

Just on a pure yield momentum play over the medium term this cross should be closer to 0.90.

If the FOMC keep the lid on more accomodation tonight this should also strengthen the case for continued CAD strength...

abee crombie said...

Toronto aka T.Dot, has a nice housing bubble in addition to vancouver. apparently most cranes in the world in any city there now.

Few other interesting stats:
Residential investment, '11 at 6% of GDP vs US bubble top of 6.3%
Homeownership rate at 70% (higher than US bubble peak)
CMHC (canada crown corp) gurantees most mortgages. Not much bank or subprime lending that isnt
Canadian renew mortgages every 5 years (using a 30-40 years term), so rising rates are the biggest risk

IMHO Canada RE is driven 50% by recent momentum/low rates
50% asian money

Also Canada oil sands exports still ramping up,so explains why exports not running so high yet

Charles Butler said...

Abee - was back in TO for a while in October. Smelled distinctly, God forbid, of 1987 - restaurant reservations required mid-week, three BR Portuguized semis for 600 grand. But the bourgeoisie seemed to be enjoying itself.

abee crombie said...

$600K CAD or pounds? you cant buy much with 600 CAD in Toronto proper, outside the city you probably could.

Asian buyers pushing up prices in North York to over $1M for 1960's 1700 sq foot bungalow.. b/c of the school district!


Toronto is starting to look a lot like vancouver, NYC, moscow, london etc

Charles Butler said...

I'm a year out of date, but we're talking 1920's 1200 sq ft, semi-detached, 200 sq ft of yard. Worse, whatever charm it might have had - the angel stone 'brick' facing, interior drywall repartitioning, etc. took care of that. Has to be seen to be believed.

So, 700K CAD

Игры рынка said...

forget cad. what about eur/czk?

following the recent industrial production disaster in germany czk looks ripe for a rip-off. or?

Leftback said...

Spain downgraded by S&P. Yawn.... didn't see that one coming..... I didn't expect a kind of Spanish Inquisition.

Here are the ratings agencies in action:

Spanish Inquisition

"Our chief weapons are... surprise...."