BOC Rate Hike A Sure Thing?
In line with recent comments from the Bank of Canada, which have taken a sharply hawkish shift, markets are widely expecting a rate hike tomorrow. With market pricing for a rate hike having surged above 92% (as shown by OIS) in recent weeks the key issue now will be what the bank signals going forward. The question is whether a hike at this meeting will represent the merely a normalisation of policy, following the rate cuts which started in 2015, or the start of a full hiking cycle.
BOC Courting Hawkish Expectations
Notably, the BOC ha actively encouraged rate hike expectations head pf tomorrow’s meeting instead of trying to dampen them. Speaking to Handelsblatt last week the BOC governor echoed deputy governor Wilkins comments saying that “when you are driving towards a red stoplight, you ease up on the accelerator well before you get there”.
Furthermore, Poloz downplayed the fact that inflation remains subdued, forecasting it to move back into an uptrend in H1 2018 also adding that recent macro-prudential measures will help reduce housing market risks over time. The importance here is that the BOC is choosing to downplay risks to the economy and instead, highlight its preference for normalizing policy.
BOC Downplay Risks to the Outlook
The BOC cut rates twice in 2015 as Oil prices cratered over 2014/2015. Following the cuts, an 8% decline in the real effective exchange rate for CAD helped the economy rebalance. Residential investment and net exports were able to mostly mitigate the downside from weaker consumption and business investment. Risks to growth still remain, however it seems the BOC is now comfortable enough with the outlook to raise rates.
Data Printing Favourably
Recent data points have been highlighting strength in the Canadian economy, further emboldening CAD bulls. Indeed, the latest positioning data shows that CAD short positions have been rapidly paired as traders have reacted to comments and data. Friday’s Canadian jobs report was better than expected with the headline Unemployment rate falling back to 6.5% a level which, aside from April this year, was last seen in 2009.
Economist Surveys Show Rift
Interestingly, despite the market pricing, it appears that BOC watchers are split ahead of the July meeting tomorrow. The recent Bloomberg Survey shows that 18/26 (or 69%) of economists/forecasters surveyed are calling for a July hike. In contrast only 15/31 (48%) surveyed by Reuters are calling for a July hike
The interesting is the fact that the BoC does actually take into consideration what economists/forecasters think, which is the reason why they conduct surveys of expectations. However, the unknown element is how much weight the BOC assigns to these surveys. Regardless, it would appear that in line with recnet comments the BOC is certainly on course to hike rates by atleast 25bps tomorrow.
Gauging Likely Market Reaction
The base case scenario in response to tomorrow’s meeting would appear to be a “Buy the rumour sell the fact” scenario. Since the shift to hawkish rhetoric, USDCAD has sold off over 4.5% and almost 7% since the year’s highs. With this in mind it seems unlikely that CAD is likely to gain much more ground tomorrow if the BOC does simply raise by 25bps.
The key decider will be what the BOC signals about further rate rises: if the bank raises but signals that it is likely to remain on hold for the rest of the year then CAD longs will be looking to take profit. However, if the bank signals that further rate rises this year are probable then we could indeed see further CAD upside.
USDCAD has now well and truly broken down below the rising channel that has framed price action over the last 12 months. The recent January and February lows around 1.3020 provide resistance overhead while the August 2016 low around 1.2760s is the next key support
CADJPY has stalled at a test of the key 88.60s/80s resistance which has been a key pivot for price over the last three years. A break above this level opens the way for further upside while a retrace lower will bring a retest of the broken bearish trend line into focus.