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Canadian Dollar Outlook Hinges on Inflation, BOC Rate Cut Odds

Canadian Dollar Outlook Hinges on Inflation, BOC Rate Cut Odds

2019-11-19 22:30:00
Rich Dvorak, Analyst
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CANADIAN DOLLAR PRICE OUTLOOK EYES CANADA INFLATION REPORT & BOC INTEREST RATE CUT BETS

  • Canadian Dollar overnight implied volatility measures jumped higher ahead of the high-impact release of the monthly Canadian inflation report which could materially sway BOC rate cut odds
  • Spot USD/CAD price action could keep climbing higher while spot CAD/JPY remains at risk of further downside if Canada inflation data shows signs of softening
  • For comprehensive fundamental insight on the Canadian Dollar, check out this USD/CAD Forecast: Will the Bank of Canada Capitulate?

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The Canadian Dollar will likely take the spotlight during Wednesday’s trading session in light of the high-impact event risk surrounding the Loonie. CAD price could get a serious jolt from Canada inflation readings for October due tomorrow at 13:30 GMT, which carries the potential of materially swaying Bank of Canada (BOC) interest rate cut expectations and follows last week’s dismal jobs report and housing data release. As such, overnight implied volatility measures for major Canadian Dollar currency pairs have ticked higher headed into the Canadian inflation report release.

CANADIAN DOLLAR IMPLIED VOLATILITY & TRADING RANGES (OVERNIGHT)

Canadian Dollar Implied Volatility USDCAD CADJPY EURCAD GPBCAD AUDCAD

USD/CAD overnight implied volatility jumped to 5.6% from the prior day’s reading of 3.9%. This compares to the 20-day average of 4.2%. CAD/JPY is expected to be the most volatile Canadian Dollar currency pair with an overnight implied volatility of 7.9%, but this ranks in the bottom 40th percentile of readings taken over the last 12-months despite being slightly above its 20-day average reading of 7.3%. Options-implied trading ranges are calculated using 1-standard deviation (i.e. 68% statistical probability price action is contained within the implied trading range over the specified time frame).

Read up on the Top 10 Most Volatile Currencies and how to trade them.

CANADIAN DOLLAR RISK REVERSALS (OVERNIGHT)

Canadian Dollar Implied Volatility USDCAD CADJPY EURCAD GBPCAD AUDCAD

Broadly speaking, forex options traders appear to have a bearish bias toward CAD price action ahead of the Canadian inflation report according to overnight Canadian Dollar risk reversal readings. Moreover, bearishness toward the Canadian Dollar seems to be gaining pace judging by the trend and changes in overnight CAD risk reversals.

A risk reversal reading above zero indicates that the demand for call option volatility (upside protection) exceeds that of put option volatility (downside protection). For additional insight on market positioning and bullish or bearish biases, traders can turn to the IG Client Sentiment data, which is updated in real-time and covers several currency pairs, commodities, and equity indices.

BANK OF CANADA – KEY INFLATION INDICATORS AND TARGET RANGE

Chart of Canadian Inflation Indicators

The Canadian inflation report matters to Loonie forex traders due principally to the fact that it stands to weigh on the market’s expectations for future BOC interest rate cuts. This is because the Bank of Canada’s governing mandate is inflation targeting. The image above depicts the key inflation indicators tracked by the BOC and reveals that Canada inflation figures remain roughly on par with the central bank’s symmetric 2% inflation target. Correspondingly, evidence of softening inflation across Canada could motivate the Bank of Canada to capitulate and cut its benchmark interest rate for the first time since July 2015.

CHART OF CANADIAN INFLATION & EMPLOYMENT

Chart of Canadian Inflation and Employment Historical Data

I noted mid-October in my article Canadian Dollar Outlook: USD/CAD, EUR/CAD, CAD/JPY, GBP/CAD how bullish Loonie prospects were likely at risk of dissipating – particularly if evidence of sluggish job growth began to weigh negatively on Canadian inflation. Alas, the upcoming release of Canadian inflation could cause a protracted selloff in the Canadian Dollar if inflation slumps.

BANK OF CANADA INTEREST RATE CUT PROBABILITIES (MARCH 2020)

BOC Bank of Canada Interest Rate Cut Probabilities Chart

According to overnight swaps pricing, the likelihood that the Bank of Canada will cut its policy interest rate by the central bank’s monetary policy update scheduled for March 2020 has teetered roughly around the probability of a coin flip so far this month. That said, the Canadian inflation report due for release this Wednesday could cause a sizable repricing in BOC rate cut expectations and have an above-average impact on CAD price action. There is currently a 47.4% probability that the BOC cuts rates by March 2020, which is up noticeably from a 34.8% probability priced by overnight swaps on November 07.

Read More – Canadian Dollar Forecast: USD/CAD, CAD/JPY, NZD/CAD Levels to Watch

-- Written by Rich Dvorak, Junior Analyst for DailyFX.com

Connect with @RichDvorakFX on Twitter for real-time market insight

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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