Central Banks are the “thick sticks” in the Foreign Exchange market. Central Bank announcements can (and frequently do) flip trends on their heads or accelerate directional moves. Bottom line: traders need to pay attention.
Ahead of today’s Bank of Canada interest rate decision, it is important to understand where the Canadian economy stands, what improvements (if any) there have been since the previous meeting, and how the markets are trading as we approach the decision. This way, we will be prepared for whatever scenario plays out – whether it is a hawkish surprize or not.
The Macro View
At the last meeting in September, the BoC left its policy rate unchanged at 0.50%, noting that the
“risks to the profile for inflation have tilted somewhat to the downside since July” but added “the Bank’s Governing Council judges that the overall balance of risks remains within the zone for which the current stance of monetary policy is appropriate”.
In order to generate logical scenarios regarding the potential stance of the Governing Council at this point in time, we need to understand how the key sectors performed during the past month. The question is: what improvements have their been, if any? What stance does the cold, hard data justify?
The economic data output issued since the last meeting reflects a strong rebound, mainly on the back of a normalisation of production in the oil sector following disruption from the wildfires in Alberta. But is it enough to justify a hawkish tilt this time round?
- Consumer Spending has risen
- Labour market has stabilized. The headline employment print continued to surprise to the upside at +67.2k, the highest increase since March 2012. However, this rise was mainly a result of a boost in self-employment, a relatively volatile category.
- Housing market has improved
- Ivey PMI and Activity indicators have marginally improved: monthly GDP rose 0.5% in July, beating expectations and following a 0.6% increase in June. The goods-producing side of the economy was the main contributor to growth in July, led by a surge in the energy sector.
- Crude Oil is higher
- Inflation is lower, and this is the only negative point. However, it is also a very important point since the Bank of Canada pursues an inflation-targeting mandate. Inflation was recently weaker than market expectations, resulting in a moderation in the year-on-year rate to 1.1%.
In a recent speech, Deputy Governor Wilkins was also quite dovish, speaking about uncertainties that were due to “future growth prospects for investments in the United States” and the possibility that “the effect of lower oil prices on the American economy is not as positive as anticipated”. Apparently, businesses have not really seen any impact from the fiscal stimulus either and the BoC is focused on the real impact of the recent fiscal stimulus on the real economy.
To sum up: the Canadian economy is holding up quite well and there are decisive improvements since the Bank of Canada last met. However, inflation is a concern and the Governing Council is also monitoring improvements in the USA. Since these uncertainties still persist, it is unlikely that Governor Poloz will turn hawkish. Baseline scenario is for no change in rates, and for a moderately dovish statement hinting that the Bank requires further information (wait & see stance). This also means that a hawkish stance would drastically surprize the markets and cause the most volatility.
Admittedly, what seemed to be initial Loonie strength this week has gradually flipped to marginal weakness across the board, but especially against Nzd and Gbp.
So if our suspicions are correct, and Poloz sticks to his previous script, then it is logical to expec further weakness in the Loonie. We think this is best exploited against Nzd and Gbp.
NzdCad has been printing higher lows all week and with a green light from Poloz, it’s easy to envision an extension towards last week’s high at 0.9500/20 and potentially higher to 0.9600. This stance is also facilitated by retail positioning indicators, which reveal increasing short bets on Kiwi.
A similar case can be made for GbpCad. The nearest topside focus is yesterday’s high at 1.6170/80 and then there is a decent amount of space until last week’s high at 1.6450/70. The retail crowd has been recently catching up to the Gbp downtrend, and this paves the way for a potential reversal which would no doubt result in a stop cascade as trailing stops get plucked and late shorts get squeezed.
The hawkish case, although less probable, is best exploited via UsdCad which is benefitting already from the softness in the Greenback. We are currently negative on the week and in the case of a hawkish surprize, expect yesterday’s lows to be promptly negotiated, and then there is a fair amount of space all the way to September lows.
About the Author
Justin Paolini is a Forex trader and member of the team at www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.