Commentary by Kathy Lien: BoC Preview: Cautionary Comments Could Help USD/CAD
It is a holiday here in the U.S. which means that the equity markets are closed for Martin Luther King’s Day. As a result, it should be a quiet trading day in the forex markets. The U.S. dollar is flat this morning against the euro and Japanese Yen but has weakened against the British pound and commodity currencies. It is a light week in terms of U.S. data but with the Federal Reserve meeting next week, traders will be watching all incoming economic reports. The Wall Street Journal has carried an article that suggests the Fed could raise the discount rate even while unemployment remains high. Although we agree since a jobless rate above 9 percent could still be perceived as high, the Fed still does not have any intention to raise rates until the second half of the year.
Bank of Canada: What to Expect
In the meantime, the focus is on Canada. It is a big week up North with the Bank of Canada scheduled to make a monetary policy announcement on Tuesday. There won’t be any surprises in terms of interest rates since the central bank already pledged last month to leave rates unchanged at 0.25 percent through June. However the BoC could grow more cautious which could halt the rally in the Canadian dollar. Since the last monetary policy meeting, economic data has taken a turn for the worse. Employment unexpectedly fell by 2,600 in December, retail sales grew at a slower pace, the country’s trade surplus turned into a deficit according to the latest figures, new motor vehicle sales plunged and manufacturing activity contracted for the first time since April. Although demand for Canadian dollar denominated assets increased significantly in November, the bulk of demand was for new U.S. dollar bonds sold in Canada.
Yet most importantly, the Canadian government is growing concerned about the weakness of the U.S. dollar and the strength of the loonie. The BoC previously indicated that the main risks for the Canadian economy is “persistent strength in the Canadian dollar that could act as a significant further drag on growth and put additional downward pressure on inflation.” Unfortunately USD/CAD has fallen 400 pips since the last monetary policy meeting and we are already seeing the negative impact that the strengthening currency is having on the economy. Deteriorating economic data and a stronger CAD could make the BoC less hawkish. The continuation in the downtrend of USD/CAD should rest in the hands of the BoC.
The following table illustrates the changes in economic data since the December monetary policy meeting. Stocks and bond yields are higher, but overall the economy has weakened.