Canadian Dollar Could Be Undermined by Dovish BoC, Trade Spats

2018-07-06 05:00:00

Daniel Dubrovsky, Contributing Senior Strategist

Canadian Dollar Fundamental Forecast: Bearish

The Canadian Dollar fundamental forecast for the week ahead is bearish
CAD could depreciate on a ‘dovish hike’ delivered by the Bank of Canada
Trump retaliating to Trudeau’s tariff counter measures could also be a risk

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Most eyes next week will be on a potentially vital Bank of Canada monetary policy announcement that could bring some intense volatility to the Canadian Dollar. This is because the markets are anticipating an interest rate hike from 1.25 percent to 1.50. But those bets are not 100 percent priced in. In fact, just a little over two weeks ago traders were not as certain that one could come in July.

Before Governor Stephen Poloz spoke on June 27th, overnight index swaps were only pricing in a 50-50 chance that the central bank could hike in July. Now, it stands around 80% confidence. So what did Mr. Poloz say that changed some of those bets? Well, he did acknowledge how trade uncertainty could curtail investment but he left it as an unknown impact.

However, Stephen Poloz added that business investment remains reasonably robust and that the economy is still warranting higher rates. At their last interest rate announcement in May, the central bank opened the door to its next hike. Since then, trade spats between the world’s largest economies as well as additional US tariff threats on auto imports have been causing worries as well.

But Poloz downplayed some of those concerns and maintained posture, paving the way potentially for a hike in July. However, the Canadian Dollar could be vulnerable if the central bank shows any hesitation to continue increasing lending rates depending on how they asses the global and local business environment.

The most recent Canadian CPI report could have gone better as well.

All of this may pave the way for what could be one of those ‘dovish hikes’. Not only should traders asses the BoC’s view on the global economic environment, but also how they feel about the most recent inflation report miss. Though do keep in mind that CPI, running at 2.2%, is just a bit above the middle of the central bank’s 1 to 3 percent target band. The BoC wants to keep inflation closer to the middle of it.

In addition to the monetary policy announcement, ongoing trade tensions that the country could have with the US also poses as a risk for the Canadian Dollar. Us President Donald Trump mentioned before that he intends to fight back if China retaliates to US import levies (which went into effect on July 6). At the end of June, Prime Minister Justin Trudeau announced their own plans for counter measures to US metal tariffs.

If Mr. Trump approaches the Canadian retaliation with more ‘fire and fury’, making the potential for auto import tariffs more likely, then the Canadian Dollar could be left vulnerable as a result. As such, the combination of uncertainty that Canada faces on the trade front in addition to a potentially dovish BoC makes for a compelling bearish CAD weekly outlook.