The forex market is dumber than a sack of hammers

I've said it before, and I'm saying it again. The CAD is off by about two cents today:

Canada is no Oz, mate: [W]hat seems to have caught currency markets off guard was the Bank of Canada’s commitment to keeping rates unchanged until at least next June and keeping its expected economic growth rate for 2010 unchanged, at 3 per cent. That is, it downplayed any optimism about the economic recovery because it expects the rising dollar, in the Bank’s words, will “more than fully offset the favourable developments since July.”

“Drawing a parallel with Australia, where a rate hike came earlier than expected, investors have recently been pushing up Canadian short-term yields in anticipation that Canada wouldn’t be far behind,” said Avery Shenfeld, chief economist at CIBC World Markets, in a note. “To those expecting an early rate hike in Canada, the Bank’s message was ‘not so fast.’”

How could this have been a surprise? The Bank has been excruciatingly and tediously clear on this point for months.

Comments

[Mark]

Energy is down, gold is down, S&P500 is down.

This isn't all the BoC announcement. I'd say it's mostly global movements. These factors turn up, so will the loonie. Unfortunately.

[Matt Nolan]

"How could this have been a surprise? The Bank has been excruciatingly and tediously clear on this point for months."

It is because the forex market doesn't really trust central banks a lot of the time - because they don't believe central banks can credibly commit to a future path of the cash. Look at the RBNZ, they have persistently said they aren't lifting rates until the end of 2010 and the market is now pricing in an increase at the end of this year.

There looks like there is a trade-off between credibility associated with responding to changes in the price level and the credibility required to control longer term rates. The forex market believes that central banks are now revising up their growth forecasts, and that once these reach a certain point these central banks will turn around and lift rates - irrespective of what they are saying with their current set of forecasts. I guess this implies that the market believes central bank forecasts are slow to respond to economic information - and in a sense they are probably right.

[Kosta]

I agree with Matt's comments, although Stephen has a point. The BoC has been saying for months that it feels that the rising Loonie is a drag on economic growth. An astute observer would realize that as long as the Loonie is rising, the BoC will be less inclined to raise rates -- not just because raising rates would give unwanted strength to CAD, but also because the rising Loonie lowers inflation (just take a look at Canadian inflation over 2006-2007).

But in defence of those in the Forex market, I think Stephen's points are subtler than what is traditionally appreciated.