Whether the BoC Hikes or Not, USD/CAD And Crosses Will Move
- Overnight swaps are pricing in a 44 percent chance of a Bank of Canada rate hike Wednesday to follow July's 25bp tightening
- Implied volatility shows considerable anticipation for USD/CAD and other Canadian Dollar cross response to the event
- The deeper potential follows a dovish outcome (I like NZD/CAD, GBP/CAD and USD/CAD), but account for the hawkish (AUD/CAD)
Event risk can generate serious volatility which draws speculators' attention. However, volatility can lead to quick losses just as readily as quick gains. Download the Trading Event Risk guide on the DailyFX Trading Guides page.
There were three major rate decisions scheduled for this week. The Reserve Bank of Australia's (RBA) decision passed with little excitement Tuesday morning, the Bank of Canada's (BoC) judgment is due later today and the European Central Bank (ECB) is set to weigh the persistence of its dovishness Thursday. Of these meetings, the ECB would be considered to be the most important policy event of the week. That is certainly true for absolute reach to the global financial system. As the second largest central bank in the world with the largest non-standard QE program in Dollar terms, it defines the absolute extreme of dovish accommodation. However, its particular meeting this week does not carry the greatest potential for short-term, target currency volatility. That distinction goes to the BoC meeting and the Canadian Dollar's response.
With the exception of the Federal Reserve, the BoC is the only major central bank that is currently in the midst of a tightening cycle - as restrained as it may be. That confers unique value to the Canadian currency when the backdrop of extremely low rates puts a greater premium on forecasts for higher returns than current yields. The faster the pace of tightening is projected to be, the more speculative inflow a currency earns. And, as the Fed turn of fortune has demonstrated, a deceleration - or reversal to further easing - can lead to a substantial decline for the local currency. Despite the Canadian central bank's move to lift its benchmark rate in July, the market believes the next move is nigh. While there are higher probabilities afforded to meetings later this year, swaps are anticipating a 44 percent probability of a move by the group at today's gathering. While that is far from certainty, it is more than enough to charge speculation that has grown hypersensitive to any whiff of tightening further into the future (hence the Euro's 2017 performance).
If we used the swaps market as our baseline for broad market anticipation, it would seem that the more market-moving outcome would be a hike. It would theoretically catch 56 percent of the market off-guard and encourage speculative adjustment to the move. However, we need to take into consideration not just the rate forecasts backed out of derivatives, the performance of the underlying market factors in as well. Over the past three months, the Canadian Dollar has surged with moves like USD/CAD, CAD/JPY and GBP/CAD showing remarkable progress. While the balance of favor may be towards no change, the market is pricing the currency as if a steady pace of rate hikes is baked in. Therefore, it is easier to trigger disappointment and generate a bigger dive from the currency than gain. For a 'dovish' outcome, my preference leans towards USD/CAD, GBP/CAD and NZD/CAD which have stretched and have fundamental contrast ready to take advantage of a BoC disappointment. When it comes to extending the Canadian Dollar's run, the options are fewer and require more motivation to extend. The exception is AUD/CAD where the first hike from the BoC has afforded little progress against an Aussie Dollar that has found little support from the RBA. As for EUR/CAD and CAD/JPY, the anticipation and uncertainty in the ECB decision and risk trends is an unknown factor better left out of the already unknown equation. We discuss the trade scenarios in the BoC rate decision in today's Strategy Video.
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