Kathy Lien | Jan 16, 2018 15:43
By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Wednesday’s Bank of Canada monetary policy meeting is the most important event risk this week and according to interest rate futures, investors are currently pricing in 90% chance of a 25bp rate hike, which would take interest rates to 1.25%. Many believe that a rate hike is a done deal but we are skeptical because as shown in the table below, Canadian oil prices and housing activity weakened since the last policy meeting. Manufacturing sector growth also slowed while the trade deficit ballooned. There’s no question that the economy in general has improved with retail sales, GDP growth, CPI and employment activity improving significantly since early December. Yet the BoC has more options than to raise interest rates immediately. These 3 possibilities could have distinctly different outcomes for the Canadian dollar:
Scenarios 1 and 2 are most likely and depending on BoC chooses, the reaction could be very different. If it hikes but downplays the move and refrains from suggesting there’s more to come, USD/CAD will break 1.24 and potentially test 1.2350, but then recover quickly. If BoC passes but prepares the market for a March hike, USD/CAD could jump to 1.25 but retreat from that level aggressively. A quarter-point hike coupled with a hawkish guidance will see USD/CAD down to 1.23.
Since the last policy meeting in December, the Canadian dollar appreciated 2%, which is significant but also restrained ahead of a potential rate hike. With less than 24 hours to go before the rate decision, we have not seen material demand for the loonie, which indicates that traders are cautious about buying the currency so there could be significant room to the downside for USD/CAD.
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