In this weeks segment I want to take the opportunity to review the USDCAD post federal elections and ahead of today’s BOC meeting. This pair is particularly sensitive to commodity pricing, as oil exportation is the largest contributor to the GDP, with the loonie often regarded as an inverse oil price proxy.
BOC most likely on hold
Today the Bank of Canada (BoC) holds its October monetary policy meeting, just three days after Monday’s Federal election.
After the escalation of global growth concerns this summer, the Canadian domestic economy has finally begun to demonstrate signs of stabilization, with estimates suggesting GDP growth looks likely to uptick in the third quarter after emerging from the technical recession it entered in the first half of 2015. Recent improvements would appear sufficient to keep the BOC benchmark interest rate on hold at 0.5%, as is market consensus.
Markets attention will focus on the language in the statement, and this is likely to be the catalyst to drive CAD price action. It is most likely that the statement will retain a dovish posturing. As with the FOMC, the conundrum for the BOC will be the deteriorating global outlook versus the spring shoots of domestic stabilization. The statement is likely to reference a mixed outlook. It will also be important to watch for any direct reference to the currency as it has seen significant strengthening in recent weeks, any reference would be a noteworthy dovish development and could have a significant near-term impact.
Under the current economic conditions, it is unlikely that the BOC will make any meaningful alteration to its forecasts for domestic growth or inflation. The risks are skewed to the downside at the moment particularly with depressed energy prices and softer global growth outlook. The non-energy contribution to the economy continues to demonstrate sighs of positive development, broadly in line with BOC forecasts. The major issue for the BOC is the precipitous decline in energy exports witnessed in the August data coupled with a renewed collapse in energy prices which has broadened the trade gap. Exports ex-energy have however continued to uptick since the last meeting, with the BOC’s Business Outlook Survey noting:
”firms’ expectations continue to diverge as they gradually adjust to an environment of weaker commodity prices and a lower Canadian dollar. The overall sales and investment outlook improved … however, business sentiment remains weak for firms directly and indirectly tied to the resource sector.”
FED Watch For The BOC
Another major consideration for the BOC is the FED and the implications of a potential rate move. Since the last BOC meeting US data has been mixed particularly in terms of employment and consumption, the less than stellar data has sidelined the FED for now, with most economists looking to 2016 for a likely US rate lift-off. The stagnation in the US is another major contributor to the decline in energy exports for Canada with he US being its largest trade partner in this regard. This fact is foremost int he mind of the BOC, who have stated concern regarding future Oil prices, specifically with respect to business investment plans and the impact of a lower for longer price environment. The BOC back in its July meeting were working on the premise of $60 per barrel WTI, these estimates will have to be revised and could contribute to commentary in the statement to downside risks.
The big elephant or panda in the room will be concerns regarding China and the emerging markets rout of late. Like the FED, the BOC will likely attest to the implications of these concerns while the declines in the CAD have buffered the decline in commodity prices. The CAD is a key release valve for additional pressure from commodity price drops, with the dual support of aiding growth on non-energy exports.
The challenge for the BOC is the USD side of the equation. The global growth slowdown and its impact on US domestic growth, would hamper the economic outlook of the Canada, coupled with commodity price concerns this combination will likely keep the BOC very sensitive to CAD pricing.
It is worth remembering that the BOC did make specific reference to the domestic currency strength in the May meeting statement. Price action of late has replicated the decline witnessed around the May meeting with Oil establishing and the USD pulling back from the upper end of its range. If these dynamics are sustained it is likely that the BOC will jawbone these effects in line with commentary from other major central banks, this will most likely take the form of general comments regarding the importance of the domestic FX rate to domestic growth and inflation.
On inflation, BoC Governor Poloz repeated in a September 21st speech that the Bank sees underlying inflation as below the midpoint of the 1-3% target range, even as the core CPI measures has held modestly above the midpoint for each of the past 13 months. With a persistent positive output gap and the weaker FX rate likely providing a transitory boost to some imported goods prices, the Bank sees the underlying trend in inflation as 1.5-1.7% y/y. It is most likely this view will be maintained at this month’s meeting.
The surprise win of the majority government for the Liberal Party at Canada’s Federal election this week adds some clarity to what, just a week ago, looked likely to be a highly uncertain political outlook. While the prospects for higher fiscal deficits, and their implications for future growth will likely factor into the long-term stance of monetary policy and the growth outlook, it is likely too soon for the BOC to make broad assumptions about the fiscal stance in their growth outlook.
Summarily, expect the Bank of Canada to leave its benchmark overnight rate unchanged at 0.5% at their meeting today and adopt “wait and see” stance. The domestic economy does appear to be showing some long-desired signs of stabilization after entering a technical recession in the first quarter, but risks from the international backdrop have risen. This should leave risks around the statement and forecasts on the dovish side, and the potential for a more direct statement on the currency.
Trading Take Away
Please take time to review the Trade Of The Day for the trading strategy I am seeking to deploy in the USDCAD. For updates on this trade set up and the other trades I am currently monitoring be sure to follow me on Twitter @LFXPatrick