USD/CAD: Trading the Bank of Canada Interest Rate Decision

Trading the News: Bank of Canada Interest Rate Decision

Why Is This Event Important:

As the economic recovery in Canada gathers pace, the central bank is widely expected to normalize policy in the second-half of the 2010 as Governor Mark Carney aims to balance the risks for growth and inflation. However, as policy makers in the U.S., Canada’s biggest trading partner, maintain a cautious outlook for the world’s largest economy and holds a dovish bias for monetary policy, Mr. Carney may surprise the market and keep rates on hold as the European debt crisis weighs on the global financial system.

What’s Expected:
Time of release:        06/01/2010 13:00 GMT, 9:00 EST
Primary Pair Impact :    USDCAD
Expected:         0.50%
Previous:         0.25%

Will This Be Market Moving (Scenarios):

A Bloomberg News survey shows 25 of the 27 economists polled forecast the Bank of Canada to raise its benchmark interest rate to 0.50% in June from the record-low of 0.25%, while investors are pricing a 68% chance for a 25bp rate hike according to Credit Suisse overnight index swaps. As the recovery gathers pace, the BoC may show an increased willingness to normalize policy further in the second-half of the year, and hawkish comments following the rate decision could produce a bullish reaction in the Canadian dollar as the central bank raises its assessment for the economy.

The Upside

As economic activity expands at the fastest pace in over a decade, with 2010 marking the “turning point when private sector demand takes over from the public sector as the primary source of growth,” Governor Mark Carney may see scope to increase borrowing costs throughout the second-half of 2010 as growth prospects improve. As a result, if the central bank raises its outlook for growth and inflation and adopts a hawkish outlook for future policy, the Canadian dollar could strengthen across the board as price pressures are expected to hold above the 2% target over the following year.

The Downside

However, as the marked appreciation in the exchange rate weighs on growth, with the European debt crisis dragging on the global financial market, the BoC may surprise the market and hold borrowing costs at the record-low in an effort to support the private sector. At the same time, the central bank expects investment in housing to “weaken markedly throughout the remainder of 2010 and well into 2011” as the government stimulus tapers off, and Mr. Carney may hold a neutral policy stance going into the second-half of the year in an effort to mitigate the risks for the economy.

How To Trade This Event Risk

Trading the given event risk favors a bullish outlook for the Canadian dollar as market participants speculate the Bank of Canada to normalize policy further in June, and price action following the rate decision could set the stage for a short dollar-loonie trade as interest rate expectations improve. Therefore, if the BoC raises the benchmark interest rate and adopts a hawkish outlook for future policy, we will need to see a red, five-minute candle following the announcement to generate a sell entry on two-lots of USD/CAD. Once these conditions are fulfilled, we will set the initial stop at the nearby swing high or a reasonable distance after taking market volatility into account, and this risk will establish our first target. The second objective will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its mark in an effort to lock-in our profits.

In contrast, the fragile state of the global financial system paired with the downside risks for growth could lead Governor Carney to surprise the market in June, which could weigh on the exchange rate as interest rate expectations falter. As a result, if the BoC holds borrowing costs steady at the record-low and maintains a neutral policy stance next month, we will favor a bearish outlook for the Canadian dollar, and will follow the same strategy for a long dollar-loonie trade as the short position mentioned above, just in reverse.

Impact that the Bank of Canada Rate Decision has had on CAD during the last meeting

April 2010 Bank of Canada Interest Rate Decision

The Bank of Canada held the benchmark interest rate at 0.25% in April as widely expected, but raised its assessment for the economy as the recovery gathers pace. The central bank said inflation will be “slightly higher” than its 2% target for inflation, and said that “it is appropriate to begin to lessen the degree of monetary stimulus” as the outlook for future growth improves. As a result, the BoC dropped its “conditional commitment” to hold the interest rate steady until July, but went onto say that the marked appreciation in the exchange rate will drag on growth as it curbs the competiveness of Canadian goods on a global scale. Nevertheless, policy makers lowed its growth forecast for the following year and expects GDP to expand 3.1% from an initial projection of 3.5% as the recovery is more “front-loaded,” and sees economic activity expanding 1.9% in 2012.

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario: If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the USD against the Canadian Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on USDCAD ahead of the data release.

Bearish Scenario: If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the USD against the Canadian Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on USDCAD ahead of the data release.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com