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Will Weak Canadian CPI Spark a USD/CAD Rally Above Parity?

Monday, 17 March 2008 23:28:02 GMT

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Written by Terri Belkas, Currency Analyst

The release of Canadian CPI data is likely to remind the markets of the Bank of Canada’s dovish bias following their 50bp rate cut in March, as the headline CPI reading is expected to ease back to 1.8 percent, while the Bank of Canada’s core CPI measure is anticipated to fall further below their inflation target of 2.0 percent to 1.2 percent.

MAR 18
Canadian CPI (YoY) (FEB) (11:00 GMT; 07:00 EST)
Canadian Core CPI (YoY) (FEB) (11:00 GMT; 07:00 EST)
 
Expected:                            1.8%
Expected:                            1.2%
 
Previous:                             2.2%
Previous:                             1.4%


What Are The Markets Facing?
 
The release of Canadian CPI data is likely to remind the markets of the Bank of Canada’s dovish bias following their 50bp rate cut in March, as the headline CPI reading is expected to ease back to 1.8 percent, while the Bank of Canada’s core CPI measure is anticipated to fall further below their inflation target of 2.0 percent to 1.2 percent. Indeed, the rapid appreciation of the Canadian dollar throughout 2007 has led import prices to plummet, which explains why CPI figures weakened so much in recent months. In fact, the Bank of Canada’s monetary policy statement released following the January rate cut did not include the key phrase “there continue to be upside risks to the Bank's inflation projection” and instead noted that they judge “that the balance of risks around its January projection for inflation has clearly shifted to the downside, and, as a result, the Bank is lowering the target for the overnight rate. Further monetary stimulus is likely to be required in the near term to keep aggregate supply and demand in balance and to achieve the 2 percent inflation target over the medium term.” While the markets are betting on a weak CPI reading, there is potential that the surge in oil over the course of February will buoy the headline figure, but either way, if Tuesday’s inflation data proves to be unexpected, the forex and Canadian fixed income markets are likely to respond immediately.
 
Bonds – 10-Year Canadian Government Bond Futures






After putting in a new high this afternoon, Canadian Government Bonds futures backed off, leaving the daily chart to form a doji. If Canadian CPI proves to be stronger than expected, or if equities rally on the FOMC rate decision in the US, there may be further declines in store. However, with the uptrend still very much intact, upside potential remains and soft inflation figures or further risk aversion could propel the contract even higher (weighing yields down).


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FX – USD/CAD
 
The USD/CAD pair continues to consolidate within a rising channel below the 1.0000 level, as broad weakness in the US dollar has not had as much of an impact on this pair given the strong ties between the two countries. However, the release of Canadian CPI could shake the pair up a bit, as signs that the Bank of Canada will be just as aggressive as the Federal Reserve with their rate cuts could finally lead USD/CAD to break above parity to target the 100 SMA at 1.0138. On the other hand, a stronger-than-expected inflation report could keep the pair in its current range, especially as the data would create the potential for wider interest rate differentials in favor of the Canadian dollar going forward.
 
The other major factor to keep in mind is the Fed’s rate decision on Tuesday afternoon (18:15 GMT). For more on this, see our Fed Rate Cut special report.
 
Where do you thinking the Canadian Dollar is heading next? Discuss the topic with other traders and DailyFX analysts in the USD/CAD Forum.
 
Visit our recently updated Canadian Dollar Currency Room for specific resources geared towards the Loonie.

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Equities – S&P/TSX Composite Index
 
Last week saw the S&P/TSX rally as energy and mining companies followed commodity prices upward. However, a pullback in oil prices and signs that the liquidity crunch in the US is taking a brutal toll on the financial sector that could spread throughout the global markets send the index plummeting just over 300 points to close at 13,952.15. While the S&P/TSX recovered from a test of 12,800, it is clear that the market’s bias is a bearish one. Looking ahead, Canadian headline and core CPI are both expected to print lower, raising the probabilities that the Bank of Canada will follow the Federal Reserve’s lead and cut rates aggressively. The prospect of more accommodative monetary policy could lead the S&P/TSX to bounce back above 13,000, but any gains may be short-lived, especially if risk aversion remains the primary driver of the markets.

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Written by Terri Belkas, Currency Analyst, Forex Capital Markets LLC, DailyFX.com

Tell us what you think about this article. Email tbelkas@dailyfx.com
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