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, as the central bank maintains a cautious outlook for the region and lowers its economic forecast, BoC Governor Mark Carney may adopt a wait-and-see approach as he aims to balance the risks for the region.

What’s Expected:

Time of release:09/08/2010 13:00 GMT, 9:00 EST

Primary Pair Impact :USDCAD

Expected: 1.00%

Previous: 0.75%

Will This Be Market Moving (Scenarios):

A Bloomberg News survey shows 14 of the 20 economists polled forecast the BoC to raise the benchmark interest rate to 1.00% in September from 0.75% in the previous month, while market participants are pricing a 64% chance for a 25bp rate hike according to Credit Suisse overnight index swaps, and a rise in borrowing costs could lead the USD/CAD to retrace the advance from the previous year as the central bank normalizes monetary policy. However, the ongoing weakness in the U.S. economy, Canada’s largest trading partner, paired with the instability in the global financial system could lead the central bank to surprise the markets as it aims to encourage a sustainable recovery.

The Upside

As the region benefits from the rise in global trade, with businesses increasing production and employment, policy makers may see scope to increase borrowing costs further as the economy benefits from the “considerable monetary stimulus.” As a result, the BoC may turn increasingly hawkish towards future policy and talk down the risks for the economy, which could spur a bullish reaction in the Canadian dollar as market participants expect the central bank to withdraw monetary support going forward.

The Downside

The downturn in price growth paired with the slower-than-expected economic expansion in the second-quarter suggests that the recovery is losing pace as the effects of the fiscal stimulus tapers off, and the central bank may look to support the real economy throughout the remainder of the year as it aims to stem the downside risks for the region. Accordingly, the central bank may see scope to keep borrowing costs on hold over the coming months, and Governor Carney may adopt a dovish tone going forward as he cuts the growth forecast and continues to see uncertainties surrounding the economic outlook.

How To Trade This Event Risk

Speculation for another 25bp rate hike certainly favors a bullish outlook for the Canadian dollar, and hawkish comments following the rate decision could set the stage for a bullish loonie trade as investors weigh the prospects for future policy. Therefore, if the BoC raises the interest rate by 25bp and sees scope to normalize monetary policy further over the coming months, we will need a red, five-minute candle following the release 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 breakeven once the first trade reaches its mark in an effort to lock-in our profits.

However, as the economic outlook remains clouded with uncertainties, with the central bank lowering its growth forecast, the BoC may look to adopt a neutral policy stance as it aims to balance the risks for the region. As a result, if policy makers surprise the market and keep borrowing costs on hold, we will favor a bearish outlook for the Canadian currency, and will implement the same setup for a long dollar-loonie trade as the short position laid out above, just in reverse.

Potential Price Targets For The Release

Impact Bank of Canada Rate Decision had on CAD during the previous month

July 2010 Bank of Canada Interest Rate Decision

The Bank of Canada raised its benchmark interest rate to 0.75% in July from 0.50%, which was largely in-line with expectations, but lowered its growth forecast for the economy as the U.S., the region’s largest trading partner, faces a risk for a protracted recovery. Central bank Governor Mark Carney said that future rate hikes will be “weighed carefully” as the economic outlook remains clouded with uncertainties, and went onto say that the “global economic recovery is proceeding but is not yet self-sustaining” as the financial system remains fragile. Moreover, the BoC anticipated the economy to operate below full-capacity until the end of the following year, but sees the growth rate expanding at an annualized pace of 2.2% in 2012 amid an initial forecast for a 1.9% rise in the growth rate. The cautious remarks from Mr. Carney suggests that the BoC may look to adopt a wait-and-see approach over the coming months as it aims to balance the risks for growth and inflation.

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