The forex market is dumber than a sack of hammers

Or maybe it's just the people who comment on its gyrations. A Reuters piece from today is a case in point:

Loonie slips on US economic outlook: The Canadian dollar slid lower against the U.S. dollar as investors were loath to bet on the currency, given Canada's heavy dependency on the waning U.S. economy...

Huh?

Yes, the Canadian economy is exposed to the risk of a severe US downturn, so it's reasonable to expect a depreciation against currencies that are better insulated, such as the euro or the yen. But that reasoning also means that the CAD should appreciate against the currencies of economies that are less insulated from a US recession. A good example of an economy that is more exposed than Canada is to a US recession is - wait for it - the US.

Unless someone has a story in which a Canadian slowdown would be even more severe than what will hit the US - and I've yet to see anyone explain how it will - then this story from Reuters makes no sense at all.

Comments

[reason]

Is that unusual for market commentaries? They are mostly nonsense.

[Jim Rootham]

Canada is a) a smaller economy, b) more dependent on trade. A reduction in US economic activity might well produce an even larger reduction in Canadian economic activity. In fact, a check of the historical record may well show that is is the expected pattern. I don't have access to the stats but my memory of the history of US recessions makes me think that is the case.

This is even before considering that part of the US response to a recession is to become more protectionist and to cut back on imports.

[Alan]

I'm reminded of this post from Felix Salmon's blog. From his post, Bloomberg had said:

The Canadian dollar fell for a fourth day as investors sold commodity-linked currencies on speculation U.S. subprime mortgage losses will slow the world's largest economy.

To which Felix commented:

Yep, the Canadian dollar fell against the US dollar on subprime worries. Or, to put it another way, the US dollar rose on subprime fears.

[Toro]

It made no sense when the loonie was at 62 cents and it made no sense when it was at $1.10, so why would it make sense now?

[SvN]

I think the model that people have in their minds is that a US recession is bad for world commodity prices, and that this is bad for the CAD. Given that commodity supply, esp. in the short run, is pretty inelastic to variations in demand, it seems reasonable to think that weaker world demand will create a negative terms of trade shock for Canada.

Now, it is possible that they're thinking of an even more perverse scenario based not on terms-of-trade effects but on portfolio balance effects. Suppose that (a) the credit crisis in the US increases international market volatility, and (b) as volatility increases, people have a strong preference for US financial assets. I suspect it is possible to construct a formal model in which the worse the US economy gets, the more people want to hold US goverment assets.