CAD vulnerable as market underprices dovish Bank of Canada risks CAD vulnerable as market underprices dovish Bank of Canada risks CAD vulnerable as market underprices dovish Bank of Canada risks

CAD vulnerable as market underprices dovish Bank of Canada risks

Forex 3 minutes to read
Charu Chanana

Head of FX Strategy

Summary:  Canada’s economic backdrop was weakened as hinted by PMI and jobs data, while headline inflation is back in the Bank of Canada’s 1-3% target range. Market expectations underestimate the likelihood of a rate cut, with less than a 20% chance this week and just over 70% for June. If BOC was to flag an early rate cut, decoupling from the Fed, CAD is likely to weaken not just against the USD but also against other commodity currencies such as NOK or AUD.


Hard landing risks loom

  • Canada’s composite PMI has been in contraction for 10 months in a row, indicating a slowdown in economic activity.
  • Labor market data for March showed net job losses and unemployment rate rising to 6.1%, the highest in 2 years.
  • February CPI eased to 2.8%, falling within the BOC target range of 1-3%. Core measure also eased to 3.1% in February and could come in at or below the 3% upper bound in March (due April 16).
Source: Bloomberg
  • Q4 GDP growth was strong and January GDP also beat expectations. But this strength was aided by a rebound in education as Quebec strikes ended, as well as milder weather. BoC’s business survey reports the outlook remains “subdued”.
  • The government is expected to make it difficult for firms to hire temporary works in an effort to reduce temporary resident numbers. This could also pose downside threats to growth and inflation.
  • Canadian economy could face hard landing risks if the BOC opted to wait for the Fed to start rate cuts.

     

    Market not positioned for BOC rate cuts

  • Market sees less than 20% chance of a rate cut this week. This is a reminder of the SNB rate cut risk we flagged earlier in March. Note that BOC is more of a trend follower than the SNB, so the odds of a rate cut this week are still low, but not zero.
  • Market also sees a just over 70% chance of a rate cut by June.
  • Even if the BOC doesn’t view one month of labor data as a reason to start cutting interest rates yet, the economic outlook and forward guidance is likely to turn dovish.

     

    CAD has room to weaken

  • USDCAD rose above the 1.3620 resistance following the Friday jobs release which highlighted economic divergence to the US where Fed members are reiterating patience on rate cuts.
  • USDCAD saw cycle highs of 1.3899 in November, when oil prices were around the same $90/barrel mark. Oil prices are a weaker driver of CAD now, while focus is on yield differentials.
  • USDCAD needs a clear break of 1.3620 to extend the upside.
  • If BOC proves dovish, CAD weakness could be prominent against other commodity currencies that are likely to benefit from the US reflation theme such as NOK or AUD.
  • CADNOK has reversed from 8.00+ levels and testing the cluster of moving averages just above 7.82.
  • AUDCAD has moved above 100DMA and could extend gains to 0.90+ in case of a dovish BOC.
Source: Bloomberg

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