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Canadian Dollar Risk Event

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Posted by Drew Zimmerman

on Friday, 29 June 2018 15:01

Bank of Canada governor Stephen Poloz is gave a speech titled “Let Me Be Clear: From Transparency to Trust and Understanding” that will be scrutinized closely for any hints as to what the Bank of Canada will do with rates at its next meeting on July 11th. It will be so closely watched because the market it currently pricing in a 60% chance of rate hike, but that number has been as high as 80% and as low as 50% in the last two weeks. Clearly showing the market is unsure whether the bank will raise rates or leave them unchanged. If Poloz sounds hawkish, I would expect those odds to increase and that CAD would rally. If he sounds dovish/overly cautious, I think CAD could see a sharp selloff.

We have two other key economic reports before the meeting, April GDP this Friday and June employment next Friday. His speech will add insight to his leanings, but a miss on either or both of these reports would make it more troublesome to raise rates. While inflation has firmed, last Friday’s core CPI miss gives the bank no urgent need to rush into raising rates. With softness in housing numbers and the high debt levels of Canadians, Poloz has many reasons to remain “cautious” going forward. I think Poloz will only sound hawkish if he wants to keep rates moving higher to try and get back to a more “neutral rate” before it’s too late. If that is the mindset of the bank, it would take a huge miss in remaining data points to derail them. Once again, why the speech could be so important.

WTI oil prices have risen dramatically over the past several days which usually helps the CAD. The pressure to end Iranian crude shipments is a real worry for global supplies. However much of the talk last week was about OPEC agreeing to higher production levels, but big news for WTI prices was an outage at a Syncrude upgrader that took 360K bpd off the market until the end of July. This caused the front month price of crude to rally significantly. But Alberta has been stockpiling crude, unable to get enough to the US due to a lack of pipelines/rail, so the supply in Alberta to keep the pipeline full for a month shouldn’t be out of the question. Second, any crude price increase that comes from a lack of supply from Canada, does not help Canada. We saw an example of this when the wildfires wreaked havoc on northern Alberta in 2016 and cut oil supply. As the fire burned through the month of May CAD dropped 4 cents.

The recent economic data has been softening in CAD and the 2yr interest rates spreads with the US have moved out to new 11yr lows. This has brought the CAD lower, however it has held in around the 75 cent level even despite the recent miss on CPI and retail sales last Friday. The chart below shows that interest rate pressure should be taking CAD lower as the red lines show the interest rate differential (orange line) recently took out the low of the past 2cycles at around 60bps(now over 70bps). At the same time CAD has been putting in higher lows, the yellow lines, in each of these cycles. Oil prices(blue line) do explain the stronger CAD at each interest rate low, however the recent oil price action may be misleading and keeping CAD firmer than it should be.

cdnchart

We have also seen a little softness in the USD that may have helped CAD stay steady over the week, but any further USD strength will be additional pressure on CAD.


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