BOC rate decision: Sell the fact in CAD?

The Bank of Canada (BOC) rate decision is due at 14:00 GMT today. Economists stand divided on whether the central bank will hike rates for the first time in nearly 7 years.

Markets priced-in a 25bps rate hike

• If we take into account the market action over the last one month or so, then the 25 basis point rate hike looks like a done deal. The data from the overnight index swaps market shows the money markets have fully priced-in a rate hike. The probability of another rate hike in December stands at 80%.
• The USD/CAD pair topped out at 1.3793 on May 5 before hitting a low of 1.2859 on July 7. A major part of the sell-off has been a result of rate hike speculation.
• The Canadian 10-year bond yield has rallied from 1.373% (June low) to a high of 1.90% this month. Again, the major part of the spike represents heightened odds of a BOC rate hike.
• New-fixed mortgage rates have already started rising in anticipation of a rate hike as well.

CAD outlook

It is quite clear the markets have priced-in a 25bps rate hike. Hence, we could be in for a buy the rumor, sell the fact’ trade in CAD… which means the USD/CAD pair would reverse direction following a 25bps rate hike decision.

Only a hawkish forward guidance is seen yielding another leg higher in the Canadian dollar (more sell-off in USD/CAD).

What if BOC maintains status quo?

Goldman Sachs holds the view that the BOC will deliver the rate hike in October and not today. The investment bank says the central bank had to be blunt as the markets failed to pick up on subtle hints… that does not necessarily mean the hike will happen today.

USD/CAD would spike (CAD would be offered across the board) if the BOC keeps rates unchanged. As discussed earlier, the markets have priced-in a 25 basis point rate hike.

Markets seeking upside protection in USD/CAD

USD/CAD spot & 1-week 25 delta risk reversal divergence

USD/CAD spot & 1-month 25 delta risk reversal divergence

Take note of the sharp rise in the 25 delta risk reversal (representing the increased demand for calls) from July 3 onwards. Meanwhile, the USD / CAD spot has remained weak.

The divergence suggests markets are seeking upside protection. The hedging activity adds credence to the view that CAD could be offered on fact (25 bps hike). Investors may also be hedging for a potential shocker (no rate hike).

USD/CAD - Potential bullish price-RSI divergence

Daily chart

Resistance: 1.2942 (10-DMA), 1.30, 1.3045 (weekly 5-MA)

Support: 1.2832 (Oct 2015 low), 1.2764 (Aug 2016 low), 1.2654 (June 2016 low)

Observations

• Potential bullish price-RSI divergence
• Bullish price-RSI div confirmed on 4- hour chart

Commentary

• Bullish price RSI div on 4-hour chart, if followed by a break above 4-hour 50-MA (1.2947) would open doors for a corrective rally to 1.30-1.3045 (weekly 5-MA).
• USD/CAD could rally to 1.32 - 1.3250 (4-hour 200-MA) if the BOC surprises market with a status quo policy and a dovish forward guidance.
• On the downside, a daily close below 1.2832 could yield further losses towards 1.2764-1.2750, although short-term oversold conditions mean losses could be short lived.

CAD/JPY - Inverse head and shoulders failure likely

Weekly chart

• CAD/JPY could be the worst performer if the BOC surprises with a dovish policy, especially because the Yen is oversold and is due for correction…
• Inverse head and shoulders failure usually leads to sharp losses. Furthermore, confirmation of a lagging indicator - golden cross on the daily chart, also indicates the rally has reached the top.
• Watch out for a drop to 85.00 levels if the BOC disappoints expectations.