A Quits vs Hires Beveridge Curve?

Stephen Gordon, on WCI, had a nice post exploring the JOLTS data coming out of the US (Another view of the sluggish US labour market). I wanted to follow up on Stephen's idea that in 2009 separations -- both quits and layoffs -- fell to match hires. I like this idea, particularly as it seems that quits are hires are strongly correlated. My base model is that quits is dependent upon hires, i.e., if there is lots of hiring going on in the job market people are more likely to quit.

In particular I wanted to look at the equivalent Beveridge curve for quits and hires. What I'm seeing is that not only did quits fall to match the drop in hires, but that the number of quits fell further than one would expect assuming a linear relationship between quits and hires.

In the chart above I've plotted Quits versus Hires over the Dec 2000 - August 2010 period, and I've split the data into two groups. The pre-crash period from Dec 2000 - Oct 1, 2008 is plotted in black and the Nov 1, 2008 - Aug 1, 2010 data is plotted in purple. I calculated the regression over pre-crash period, and plotted this regression in blue.

Assuming the linear regression is an accurate description of the relationship between hires and quits, the number of quits, post Nov 1, 2008 have fallen below what would be expected by the number of hires. Echoing what Stephen said, I'm not sure if this is good news, but it probably has helped keep the unemployment rate from going higher.

Yet more on CAD/USD and WTI

This post continues on the discussion of the degree to which CAD/USD is influenced by WTI, and is primarily meant to add some colour to the discussion of a post by Mike Moffat over at WCI.

In earlier posts (here and here) I had argued that the price of CAD/USD was not directly influenced by the price of oil, but rather by US dollar strength (or weakness). My claim was supported by the fact that CAD/EUR, which should gauge Canadian dollar strength independent of the US dollar, was not particularly correlated to the price of oil.

Having thought about this a bit more, I want to expand on this discussion. Specifically, while it is true that CAD/USD is primarily influenced by the strength of the US dollar (as is the price of oil), one can discern periods where the price of oil is higher than one would expect solely from US dollar strength. During these periods, the Canadian dollar seems to outperform the Euro (that is CAD/EUR rises). This suggests that when the price of oil is higher than expected based on USD, it correlates with Canadian dollar strength. In other words, CAD/USD and the price of oil are correlated independent of the US dollar.

Below is a chart with WTI in the top panel on a log scale (OHLC bars). Superimposed in the panel is 1/US Dollar Index on a linear scale (which plots US dollar weakness). EUR/USD and CAD/USD are plotted in the second panel in blue and red respectively. CAD/EUR appears in the third panel.

My first comment is that log(WTI) seems to correlate much better with 1/USD than WTI, at least over the 2003-2010 period.

Second, I've highlighted three periods in tan where US dollar weakness (i.e., 1/USD) outperforms log(WTI) strength. During these periods, EUR/USD outperforms CAD/USD and CAD/EUR falls. I've also highlighted three periods in yellow where log(WTI) outperforms US dollar weakness. During these periods, CAD/USD outperforms EUR/USD and CAD/EUR rises.

Thus when WTI is stronger than what one would predict from USD (that is when log(WTI) outpeforms 1/USD), the Canadian dollar outperforms the Euro. Conversely when WTI is weaker than what one would predict from USD (1/USD outperforms log(WTI)), the Canadian dollar underperforms the Euro.

From this data I can't help but conclude that the price of oil has an independent correlation to the Canadian dollar (indpendent of the US dollar that is). But evidence of the correlation only appears when the price of WTI diverges from what one would predict solely on the basis of the US dollar.

I owe Stephen Gordon an apology for nitpicking to such a degree about his earlier post.

More on CAD/USD & WTI

Mike Moffat on WCI posted a "toy" model relating CAD/USD to the price of oil and interest rate differential between the U.S. and Canada. I've reproduced his model below:

Using the daily data from the years 2001-2006 a linear regression was run to calculate values for the toy:

MERT value = 48.62 + (0.6211*OIL) + (1.8306*INTGAP)

where:

MERT = The predicted value of the Canadian dollar (CAD/USD)

OIL = WTI Cushing Spot price in dollars

INTGAP = Target for the Overnight Rate (Canada) - Target for the Federal Funds Rate (U.S.). A 1.25% target for the overnight rate enters the equation as 1.25.

Really quite a lovely "toy" which does a pretty good job in estimating the CAD/USD exchange rate (see the above link for some graphs of its predictive capabilities). I especially like the use of WTI as a predictive term. Now WTI is strongly correlated with the inverse of the US dollar. I believe the power of the "toy" in predicting CAD/USD stems from this strong correlation.

So I was wondering about my earlier use of CAD/EUR to gauge Canadian dollar strength independent of the US dollar and thought to examine that technique in light of this new "toy". Specifically, how does CAD/EUR compare to both WTI and the inverse of the US dollar (or the US Dollar Index).

WTI appears in the top panel as OHLC bars along with the inverse of the US Dollar Index as a blue line. CAD/EUR appears in the second panel as a green line along with CAD/USD as a red line. My apologies for the busy chart.

Note: WTI is plotted on a log scale, while the inverse of USD is on a linear scale!

via Stockcharts.com
It's immediately apparent that log WTI and the inverse of the US Dollar Index are strongly correlated (I looked at straight WTI versus inverse US Dollar Index, and the log appears to be a much better fit).

I've highlighted several periods where the two signal diverge. The yellow periods indicates instances where the US dollar weakens faster than WTI strengthens (that is inverse US dollar index rises above WTI). In these periods, CAD/EUR drops as the Euro outperforms the Canadian dollar. The tan periods are instances where Inverse US Dollar Index underperforms WTI (i.e., the US dollar strengthens while WTI remains strong). In these periods, CAD/EUR rises.

What I find very interesting is that when Inverse US Dollar Index diverges from WTI, CAD/EUR follows the US dollar (the dollar index itself, not the inverse). When the US dollar weakens faster than WTI falls, CAD/EUR falls (yellow periods), and when US dollar rises faster than WTI falls, CAD/EUR rises (tan periods).

If you examine CAD/USD (red line), whatever influence CAD/EUR has on the Canadian dollar appears to be dwarfed by whatever the US dollar is doing. Post 2003, CAD/USD and CAD/EUR appear correlated, but previous to this date, changes in CAD/EUR appear to have only a small correlation to CAD/USD.

Finally, it's important to note that this approach ignores other macroeconomic variables which could influence exchange rates. In particular, Mike Moffat's "toy" model includes the interest rate gap between Canada and the US.

Update: After further thought, I'm not sure that the above figure speaks one way or another on WTI's independent influence on CAD/USD. Now it is true that CAD/EUR tends to follow USD more than WTI (yellow and tan regions). But, this is probably happening because USD is moving more than WTI in each of those bands.

I think there are better approaches, but I'll post more when I get a chance.

Is the Canadian Dollar Driven by the Price of Oil?

This post was prompted by a post by Stephen Gordon on the Worthwhile Canadian Initiative discussing the Bank of Canada and the exchange rate. I'm not trying to contradict the main point of that post, but rather I just want to add some more information.

The post discusses how the CAD/USD exchange rate is approaching parity, and notes the correlation between commodity prices and the CAD/USD exchange rate. I've reproduced Stephen's chart on this correlation below.

Clearly CAD/USD is correlated to commodity prices, but I would argue that this correlation is through USD weakness, not CAD strength. Now this seems a little strange; with Canada exporting so many commodities (particularly oil), one would think that an increase in the price of commodities (oil) which increases the total value of exports would lead to strengthening of the Canadian dollar. But if you look closely, the relationship between price of oil and the strength of the Canadian dollar is not consistent. And by the strength of the Canadian dollar I mean the strength independant of the US dollar.

Consider the strength of the Euro. Europe (or at least Euro-land) is a net importer of oil. So an increase in the price of oil should weaken the Euro, just as it should strengthen the Canadian dollar. So the CAD/Euro exchange rate should be correlated to the price of oil, with the Canadian dollar strengthening with respect to the Euro as the price of oil rises.

Below is a Stockcharts chart with 6 instruments as weekly bars for the last 10 years. The top panel has the Dow Jones Commodity Index (brown bars) and the second panel has WTI (crude oil) as OHLC bars with the CAD/Euro exchange rate as a green line. The remaining panels have CAD/USD, Euro/USD and the US Dollar Index.

Now compare WTI versus CAD/Euro. There's a 3 year period from 2005 to late 2007 where it appears that CAD/Euro is correlated to WTI. But from 2002-2005 WTI and CAD/Euro appear to be inversely correlated !?! And from late 2007 till late 2009 is appears that after a period of inverse correlation the two signals lose correlation. On the whole, it doesn't look like CAD/Euro is strongly correlated to WTI over the last 8 years. Similarly, CAD/Euro doesn't look strongly correlated to the DJ Commodity Index either (top panel, brown bars).

Now maybe looking at CAD/Euro isn't the right way to assess the strength of the Canadian dollar independent of the US dollar, but it is a good start. Given that Euro-land is a net importer of oil (and commodities?) while Canada is a net exporter, the lack of correlation between CAD/Euro and WTI (and commodity prices) would suggest that the Canadian dollar is not strongly correlated to the price of oil (or commodities).

However, CAD/USD is correlated to the price of commodities. I would suggest that this correlation is driven by USD -- that is since commodities are priced in US dollars, then a drop in USD will lead to a rise in the price of commodities proportional to the rise in CAD/USD.

Moreover, since the price of commodities is not directly influencing CAD/USD (rather USD is influencing the price of commodities), I'm not sure that the price of commodities adds much extra information when examining CAD/USD. Rather, it might be more informative to look directly at USD, such as the US dollar index -- maybe by comparing USD/CAD to the US dollar index, periods of relative CAD strength would become apparent.



(click to expand)

Has the Canadian Dollar strengthened?

The Canadian Dollar (CAD) has strengthened markedly against the US Dollar (USD) in the last decade rising from an average of CAD 0.64 per USD in 2002 to CAD 0.94 per USD in 2008, a 48% rise. What has caused the rise in CAD/USD?

One idea that seems to attract a lot of attention is that CAD/USD has been driven higher by the rise in the price of crude oil and the output from Alberta's Tar Sands (see for instance the comments in this blog: We are all Albertans - On est tous des Albertans). The idea is appealing as the dollar value of Canada's exports have clearly increased with the rise in the price of oil.

But exchange rate data doesn't generally support the idea that the rise in CAD/USD is due to the Canadian dollar strengthening, as compared to the US dollar weakening. In particular, if the rise in CAD/USD stemmed from the strengthening of the Canadian Dollar, then one should also see similar rises in the Canadian Dollar versus other currencies. Conversely, if the rise in CAD/USD has stemmed from USD falling, then one would expect to see USD fall against other currencies.

Below is a chart plotting the average monthly exchange rate for CAD/USD, CAD/EUR (Euro) and EUR/USD from January 1999*. Since 2002, both the Canadian dollar AND the Euro have strengthened considerably against the US Dollar (approximately 50% in both cases), but the Canadian Dollar versus the Euro has been flat (with some variance).

Now the Euro-area is a net importer of crude oil, and Canada (through the Albertan Tar Sands) is a net exporter. If the rise in the price of oil and output from Alberta was driving the Canadian dollar higher, then one would expect that CAD/EUR would rise? But the exchange rate has been flat (especially compared to the US crosses)

There is also a great counter-example to the idea that the price of oil has been driving the Canadian dollar higher in this data set. In the first half of 2008 the price of oil rose from $100 to nearly $150 (marked with an arrow on the chart above). This was correlated with a sharp rise in the Euro to nearly USD 1.60. The Canadian dollar was flat during this period, as if the price of oil did not influence CAD.

Now obviously this is a simplistic approach to looking at exchange rates, but it is informative. Movement in the US dollar appears to be the primary driver in the CAD/USD exchange rate. Undoubtedly there are other feedback loops, such as a drop in USD leads to a rise in the price of oil, which helps Canada's trade balance. And perhaps if Canada was not exporting oil from the Alberta Tar Sands, CAD would have followed USD lower this past decade.

But it appears that,the Canadian dollar hasn't strengthened, it's the US dollar that has weakened.

Edit: Some numbers from the chart above

Let's look at the change in CAD/USD, CAD/EUR and EUR/USD from 2002 to 2008 (2008 saw the greatest appreciation in both currencies and crude oil). Below is the average exchange for each pair for each year, plus the percent change.

CAD/USD - 2002: 0.637, 2008: 0.943, change: +48%
EUR/USD - 2002: 0.945, 2008: 1.471, change: +56%
CAD/EUR - 2002: 0.676, 2008: 0.642, change: -5%

*Canadian dollar exchange rate data from Bank of Canada, Euro/USD exchange rate data from the ECB website. Euro/USD monthly exchange rates calculated as the average of the first 21 trading days from the start of the month.

Oh Canada

There's been a spate of articles on Canadian banks this past week -- perhaps that's a sign to sell. But here's a look at the market capitalization of North American banks from Yahoo Finance. RBC is number 3, while TD and BNS are numbers 6 & 7. For some reason Bank of Montreal doesn't show up on the list, but their market cap is about $12 B, which would put them tenth spot.

Looks like we might rally for a bit

Vix is a pretty reliable indicator of whether equities are in an uptrend or a downtrend. In particular, when Vix is below its 20 dma, the markets usually are rallying. Today, Vix once more broke below its 20 dma, and by the looks of it, Vix is heading lower (top panel).

The equity-only put/call ratio (CPCE) confirms this viewpoint. The 9 EMA of the put/call ratio after rising last week, appears to be heading lower, which is bullish for equities (blue line, second panel).

I've picked up another technique for utilizing the CPCE to mark intermediate tops and bottoms from Cobra's Market View. It involves drawing descending trendlines from highs in the CPCE (which correspond with lows in equities). After these highs in CPCE, the markets tend to rally, leading to successive lower highs in CPCE and hence the descending trendline. When CPCE finally breaks above this trendline, that marks an intermediate-top. The technique appears in the second panel, with the raw CPCE as the grey line. Also, the technique only works with closing CPCE numbers; intraday spikes don't count. For a better explanation of the technique, see Cobra's post.

Both Vix and CPCE are presently suggesting that equities are rallying. This picture could change with one hard day of selling, but till then, I'm long.

I would like to see the Yen weaken, but Treasuries have been selling off, and that is also supportive of equities.

CPCE analysis -- is the top in? is the bottom in?

This is in response to a nifty put/call ratio analysis presented by the Financial Ninja. His analysis uses the CBOE put/call ratio and suggests that a top is being put in, not a bottom.

I prefer the CBOE equity-only put/call ratio, which I think might give a truer signal of traders intentions. I've repeated The Financial Ninja's analysis using the equity-only ratios ($CPCE on Stockcharts instead of $CPC).

Like the Financial Ninja's method, this method does a good job of identifying the majority of tops and bottoms since 2007. A closer comparison of the two ratios might suggest one or the other is better a picking up a couple of the highs and lows around the turn of 2008.

The real difference in the methods, however, is the $CPCE is not let looking like it will call a stop (it's close, having started to turn over, but its not quite there).

I'm not sure which indicator is more accurate, although I am partial to the equity-only put/call ratio

Fed's Open Market Operations

Amazing picture which I have to repost from Alea's FRBNY: Domestic Open Market Operations during 2008

Credit indices

The Credit Default Swap indices have been improving this. Even with today's sell off, these indices appear to be heading south -- which should be supportive of equities.

Here's the US Investment Grade Index (from Credit Derivatives Research). By the looks of it, this index put in a lower high -- a lower low would be bullish

CDR's US High Yield index is on the right, a head
and shoulder's formation.

CDR's Europe Investment Grade Index is on the left. Another head and shoulder's formation.







CDR's Europe Crossover (mostly high yield) is on
the right. This is the worst performing index --
it has not yet clearly turned over, a new high would be bearish for equities.




In spite of today's sell off in equities, all four of these indices have signs of improvement.

Markit's ABX and CMBX's indices were also showing signs of improvement, but today they paused. Here's Markit's CMBX-NA-AAA 4 index , it bounced off of the previous lows.