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

Trading the News: Bank of Canada Interest Rate Decision

Why Is This Event Important:

However, the instability in the global financial system paired with the uneven recovery in the world economy could lead the Bank of Canada to adopt a wait-and-see approach this month, and dovish commentary following the policy meeting could lead the USD/CAD to extend the advance from the monthly low (1.0275) as interest rate expectations falter.

What’s Expected:
Time of release:        07/20/2010 13:00 GMT, 9:00 EST
Primary Pair Impact :    USDCAD
Expected:         0.75%
Previous:         0.50%

Will This Be Market Moving (Scenarios):

A Bloomberg News survey shows all of the 20 economists polled forecast the BoC to raise the benchmark interest rate to 0.75% from 0.50% in June, with investors pricing a 96% for a 25bp rate hike according to Credit Suisse overnight index swaps, and the central bank may see scope to normalize further over the coming months as the private sector activity improves. At the same time, policy makers in the U.S., Canada’s biggest trading partner, have maintained a dovish outlook, with the Federal Reserve maintaining its pledge to hold borrowing costs close to zero for an “extended period” of time, and BoC Governor Mark Carney may look to hold the interest rate steady this month in order to avoid choking off the recovery.

The Upside

As the labor market improves, with households and businesses increase their rate of consumption, the central bank may shift gears and hold a hawkish outlook for future policy in an effort to curb the risks for inflation. As a result, Governor Carney may continue to unwind the emergency measures and tighten monetary policy going into 2011 as it expects price growth to exceed the 2% target next year.

The Downside

At the same time, Mr. Carney argued that the prospects for future policy are not “preordained” as the global recovery becomes “increasingly uneven,” and the central bank may surprise the markets by adopting a wait-and-see approach as it aims to counter the downside risks for the economy. Accordingly, the central bank may continue to support the economy over the near-term and look to talk down speculation for future rate hikes as the economic outlook remains clouded with uncertainties.

How To Trade This Event Risk

Expectations for another rate hike certainly favors a bullish outlook for the Canadian dollar, and price action following the announcement could set the stage for a long loonie trade as investors speculate the central bank to normalize policy further over the coming months. Therefore, if the BoC delivers a 25bp rate hike and sees scope to raise borrowing costs further this year, we will need to see a red, five-minute candle following the rate decision 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 low 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 cost once the first trade reaches its target in order to preserve our profits.

On the other hand, the ongoing turmoil in the global financial system paired with the uneven recovery in the world economy may lead the BoC to maintain a loose policy stance going forward as the central bank aims to balance the risks for the region. As a result, if the central bank surprises the markets and holds the benchmark interest rate at 0.25%, we will favor a bearish outlook for the Canadian currency, and will implement the same strategy for a long dollar-loonie trade as the short position laid out above, just in reverse.

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

June 2010 Bank of Canada Interest Rate Decision

The Bank of Canada raised its benchmark interest rate to 0.50% in June from 0.25%, which was largely in-line with expectations, and the central bank may continue to normalize policy further over the coming months as the economic recovery gathers pace. Market participants speculate the BoC to raise borrowing costs further over the coming months as it lifts the interest rate off the record-low, but the ongoing weakness in the global financial system could lead Governor Mark Carney to adopt a wait-and-see approach as the outlook for future growth remains clouded with uncertainties. The BoC warned that the expansion in the world economy is “increasingly uneven,” while the developments in Canada have been “largely as expected,” and the central bank went onto say that “any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments.”

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