Income Strategy November 12, 2007:

There are increasing signs that the North American economy is slowing. The problems caused by the deflating of the US real estate market is deepening and creating considerable uncertainty regarding the ability of the consumer to continue their spending spree. Consumer confidence has been falling recently along with the price of houses across the country. Loan delinquencies of all types are increasing, Capital One the largest independent Visa and MasterCard issuer in the US announced an increase in charge offs for October from 2.86% to 3.28% and the US credit card industry over all has a charge off rate of 5.11% up from 4.13% in the previous quarter. All of this credit uncertainty can be tied to the declining house prices as borrowers try to keep their mortgages current at the expense of other credit obligations.

The Federal Reserve will have to be very cautious regarding the next changes in interest rates if they hold rates steady at the next couple of meetings they may end up slowing inflation but it will likely push the US economy in to recession. If they continue reduce rates they may end up staving off a recession but they will be viewed as bailing out the bad lenders and money managers and abandoning their long held position as an inflation fighting central bank. Lower interest rates will also lead to more selling in the US dollar creating additional pressure on inflation.

The weak US dollar is creating a lot of concern in Canada as the loonie surges in to uncharted territory touching $1.10 verses the US dollar. The manufacturing sector has been hit hard by the increase in the loonie and job losses continue to mount with over 60,000 jobs lost over the past year. The Bank of Canada has wisely chosen not to become involved in the debate regarding the currency, other than to state that they believe the Canadian dollar is trading well above it’s fundamental value and should trend lower.

Any time a central bank has tried to directly influence an exchange rate it has been an expensive exercise in frustration. The global currency market is enormous and it has consistently swamped any central bank effort to control the free market price of the currency. Canadian politicians are lining up to blame the Bank for the currency situation when in reality it is the weakness in the US dollar that is the problem and it is effecting not only Canada but all of the other major currencies as well. Canada is feeling the effects more directly because of our dependence on the US market regarding trade.

I am sure that the bank of Canada will stay the course regarding interest rates and will not become unduly influenced by the current politically motivated debate, if not we are all in trouble.