The Canadian dollar is reacting to the situation in the Middle East, but after recent BOC and Fed meetings, it will likely come back to focus on fundamentals. The main takeaway from the two central banks is a divergence in policy outlooks, which could leave the CAD weaker against the dollar (supporting USDCAD). However, one major element that could change this is the upcoming Canadian CPI release (ahead of US inflation later in the week).
Softer economic data from Canada has led to lower interest rates, and slower economic performance would be expected to exert less inflationary pressure. However, Canada’s economy is closely linked to the US and could suffer from spillover effects. Part of that could be mediated by tariffs, but with the new Fed Chair seemingly going on the warpath against consumer prices, there could be an impact north of the border.
BOC Signals Easing Bias Despite Energy Prices
The BOC’s policy meeting seemed to surprise markets with a dovish tone. Governor Tiff Macklem focused on issues that would imply lower rates and hardly even mentioned the potential for higher consumer prices resulting from the blockage of the Strait of Hormuz. Of course, by that time, it was known that a tentative deal had already been struck.
His focus on potential risks to growth, including noting that USMCA negotiations are likely to continue for months, suggested that the BOC is more inclined to cut than to hike. Higher crude prices would be expected to support the CAD, given its high export levels. But Macklem pointed to the situation as a greater risk to the economy, which he acknowledged hadn’t grown recently. He also underlined that the economy is not in recession, either. However, his post-rate-decision remarks were largely a list of reasons not to hike. He’s scheduled to speak later in the week, after the data release, and markets will likely pay attention to his comments to see whether there are any revisions in light of developments in the Middle East.
What the Market is Looking For
The latest inflation reading from Canada is scheduled to be published on Monday, with the headline May CPI rate anticipated to rise to 2.9% from 2.8% a month earlier. The BOC’s preferred measure, the Trimmed Mean CPI, is expected to tick up to 2.1% from 2.0% previously.
The market focus will likely be on the difference in performance between the headline and trimmed-mean measures. That will indicate if higher energy prices are filtering through the economy. If the trimmed-mean measure remains stable, then the BOC can stick to an easing bias. But if it accelerates upward, it could indicate secondary effects from higher energy prices and prompt a change in BOC rhetoric.
Will It Be Enough to Support the CAD?
However, given the slow economic performance, the CAD and BOC might be in a similar situation to the Euro and ECB. That is, higher rates could weigh on the currency, as investors fear that a more hawkish central bank will weigh on growth.
Meanwhile, there is growing concern that the Strait of Hormuz will not be reopened. Or, if it does, it could take weeks if not months for the market to adjust. That could keep WTI prices elevated in the short term and continue to provide some support for the CAD.
