Bank of Canada expected to taper, so why is CAD falling? [Video]

Of the 3 monetary policy announcements this week, the Bank of Canada’s is the most important. Back in April the Bank of Canada set the ball rolling by becoming the first major central bank to cut bond purchases. They followed up with additional policy normalization moves in July and are now expected to do taper again in October. 

Over the past month, USD/CAD has fallen 4.5% as the Canadian dollar soared against the greenback. There have been a string of positive economic reports including the unemployment rate which dropped to its lowest level in 18 months, manufacturing activity and retail sales which increased, and inflation which grew at its fastest pace in 18 years. Data like this has investors convinced that the Bank of Canada will taper tomorrow and end Quantitative Easing in December especially after Bank of Canada Governor Tiff Macklem said inflation could be more persistent than expected.
 
Yet the Canadian dollar is falling and not rising ahead of the Bank of Canada rate decision because what matters now are rate hikes. Investors can see the end of taper, but at their last meeting, the central bank said rate hikes won’t happen until the second half of 2022 at the earliest. Interest rate futures show the market pricing a full quarter point hike in April 2022 – and the sell-off in the Canadian dollar vs. the greenback or rally in USD/CAD reflects the uncertainty of whether the Bank of Canada will address rate hikes. If the central bank even teases the idea of a first half hike, USD/CAD could retest 3 month lows but if they fail to do so USD/CAD should rally in disappointment.
 
The U.S. dollar traded higher across the board on the back of stronger consumer confidence and new home sales on Tuesday.  The Delta variant doesn’t seem to worry Americans who continue to enjoy post lockdown recovery. Nearly half of the respondents expect to take a vacation over the next 6 months which is good news for holiday travel and spending. USD/JPY rose above 114, shrugging off the decline in Treasury yields. EUR/USD extended lower while GBP/USD was unchanged.
 
The Australian and New Zealand dollar will be in focus tonight with Australian inflation and New Zealand trade data scheduled for release. The Australian dollar was one of the best performing currencies on Tuesday. Aside from the prospect of a robust post-lockdown recovery, investors may also be positioning for strong CPI. Prices rose across the globe in the third quarter and even though Australia was in lockdown for a good part of that time, it is unlikely that they escaped the price increase. New Zealand is struggling with a flareup of COVID-19 cases but the recent uptick in PMIs signal stronger trade activity in September.