USD/CAD to Rise; Bank of Canada Meeting Up Next

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Forecasters are saying the Canadian Dollar will probably decline in the run up to and after the Bank of Canada rate meeting on Wednesday, March 1.

Firstly, there is the risk of Donald Trump will say something at his State of the Union Address on Tuesday 28 to push up the Dollar leading to a rise in USD/CAD.

Then there is an increasingly wide differential between 2-year US Dollar and Canadian Dollar yields.

These are often a useful way of predicting price movements in a currency as they model short-term interest rate expectations, and interest rates are a major driver of currencies.

“The 2y US-CA spread sits around 43bp.Historically, this level has been consistent with USDCAD at 1.36 (USD/CAD currently at 1.31) leaving it at a steep discount to one of its key cyclical drivers,” said strategists at TD Securities.

TD saw the discrepancy as due to the broader improvement in risk appetite which helped the CAD to some degree.

They also noted, “a large buildup in CAD long exposure. IMM data has seen net long CAD exposure over the past six weeks, and long exposure is approaching the highest level since mid-2016. Our sentiment indices show CAD with the largest buildup in long exposure over the past 3 months.”

An extreme of long positions for a currency, which means people trading the currency in expectation that it will rise, is often associated with the opposite reaction, ie the possibility of weakness in the future - but only if at extremes.

USDCADFeb28

Canadian Central Bank To Sound Pessimistic – Negative For CAD

The Bank of Canada (BOC) are meeting on Wednesday, March 1 but they are not expected to change interest rates or sound optimistic, according to analysts at Bank of America.

“We expect the BoC to stay on hold at its March meeting. We expect a dovish message given downside risks from US policies,” said BofA. Clearly there is still a threat from any adverse changes to the NAFTA agreement and this is likely to keep the BOC cautious, despite rising inflation.

Clearly, there is still a threat from any adverse changes to the NAFTA agreement and this is likely to keep the BOC cautious, despite rising inflation.

Headline Inflation has moved above 2.0% but the BOC is not expected to increase rates to try to stabilize this as it is almost entirely driven by the 20% rise in gasoline prices since 2016, as illustrated by the stubbornly low Core inflation data.

USDCADFeb28b

The Central Bank will also not wish to increase the cost of borrowing until the economy is in better shape.

“The BoC is trapped between an economy that still has slack and inflation already above 2%. We expect BoC on hold in 2017,” said BofA.

“Slack remains in the economy and therefore there are no demand pressures on prices in the horizon, with an output gap that is still in negative territory (Chart 1) and recent data still pointing to some weakness in the economy (retail sales contracted 0.5% mom sa in December),” they added.

BofA see the BOC meeting as resulting in a 0.25% widening of the 2-year yield differential between US and Canadian bonds, which would be commensurate with USD/CAD at a vaunted 1.39, and thus the exchange rate probably rising closer to their estimate.