BOC Preview: USD/CAD set to tumble on hawkish hike and optimal conditions for bears
- The Bank of Canada is set to raise interest rates despite a perceived GDP miss.
- High Canadian inflation expectations and growingly hawkish Fed rhetoric would likely trigger the same from BOC.
- Potentially weak US data released in parallel could exacerbate USD/CAD falls.
Last storm ahead of the summer – that seems to be the case for USD/CAD as it faces an imminent 50 bps rate hike by the Bank of Canada. While raising the Overnight Rate to 1.50% is in the price, a pledge to ferociously fight inflation has room to lift the loonie. Moreover, other factors also provide a backdrop for a bearish bias on USD/CAD.
Hawkish hike
As elsewhere in the world, inflation is rising in Canada. However, the northern nation is similar only to the US in suffering rapid rises in underlying prices. The Core Consumer Price Index (Core CPI) jumped by 5.7% YoY in April. That is just below 6.3% in America – yet at least it is trending down south of the border.
Canadian core inflation:
Source: FXStreet
Increases in energy and food prices are impacted by global factors which central banks cannot control. However, when inflation is widespread, the BOC can cool lending and encourage saving by raising interest rates.
As mentioned earlier, markets know that BOC Governor Tiff Macklem and his colleagues are set to fight deep inflation with a 50 bps rate hike. But, what will they signal about the future?
Inflation can become a self-fulfilling prophecy if consumers expect prices to rise and increase purchases now to get ahead of rising prices. In that, Canada already exceeds the US and many other developed economies.
Source: The Economist
Macklem needs to signal more rapid rate hikes are coming, perhaps indicating a move to tight monetary policy – raising interest rates above the level of inflation in order to choke off rising prices. Such a stance would boost the loonie.
Domestic inflation is not the only consideration for Macklem, but also the work of his peer in the US, Federal Reserve Chair Jerome Powell. The Canadian economy is highly dependent on US demand and the BOC is watching the Fed closely. The recent hawkish stance from Powell and his colleagues – Governor Waller hinted at non-stop 50 bps hikes – may also force policymakers in Ottawa to act more aggressively.
USD/CAD vulnerabilities
As I have explained, the Bank of Canada is ready for a hawkish hike, but how is USD/CAD positioned? The latest significant release from Ottawa was quarterly Gross Domestic Product (GDP) which came out at 3.1% vs. 5.4% projected. The substantial miss weakened the Canadian dollar.
On the other hand, it is essential to remember that the BOC foresaw an expansion of 3% in the first quarter – which means growth exceeded expectations. The softer loonie is ripe for strengthening.
Just as the BOC releases its rate decision on June 1 at 14:00 GMT, the US ISM Manufacturing Purchasing Managers' Index comes out. Recent US figures have mostly missed expectations, and there is room for another weak figure that would hit the dollar.
The forward-looking ISM Manufacturing PMI is trending down:
Source: FXStreet
All in all, it seems like the perfect storm for USD/CAD to resume its falls.
Final Thoughts
It is hard to see the Bank of Canada stray away from the hawkish tones of the Fed and also the European Central Bank, the Reserve Bank of New Zealand and others. The Canadian real estate market may take a hit, but the BOC may "do whatever it takes" to bring inflation to its knees.
Author
Yohay Elam
FXStreet
Yohay is in Forex since 2008 when he founded Forex Crunch, a blog crafted in his free time that turned into a fully-fledged currency website later sold to Finixio.
