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With Brexit negotiations underway, Federal Reserve officials on tour, and Trump remaining resident in the White House, potential currency volatility landmines are scattered through the week ahead – but one of the most widely-watched data releases will land on Friday when Statistics Canada releases its May inflation numbers.

Markets currently expect a print around the 1.5 percent mark, with traders broadly positioned for upside after last week’s shockingly hawkish turn from the Bank of Canada’s Carolyn Wilkins. In a speech to a business audience in Winnipeg, the woman widely tipped to become the next Governor said, “As growth continues and, ideally, broadens further, the governing council will be assessing whether all the considerable monetary policy stimulus presently in place is still required” – providing the clearest indication yet that the Bank’s next move will be a hike in interest rates.

Tighter monetary policy has been justified in Canada for many years now – and remains justified. With strong consumer spending powering the economy, the estimated neutral rate of interest has long been well above actual levels – and the Bank of Canada’s own growth projections suggest that policy rates would have to increase approximately 200 basis points to remain appropriate by the middle of next year. With both Governor Poloz and Wilkins repeatedly signalling an intention to raise benchmark rates in the near future, we have been forced to pull our interest rate forecasts forward over the past few months – a move at the October meeting, and further tightening in the early part of 2018 is certainly conceivable.

We suspect however, that vulnerabilities in the Canadian economy could keep the interest rate trajectory more depressed than markets currently anticipate. Although the slowdown in energy sector capital expenditure has unquestionably depressed economic output, the reality is that residential housing investment, financing activities and consumer spending have been the country’s primary marginal growth drivers since 2009. Foreign buyer taxes and changes in lending rules have done little to slow the accumulation of debt. Most citizens remain convinced that relative overvaluation in the Chinese yuan and other emerging market currencies will continue to support demand for Canadian housing assets, while home equity lines of credit and second mortgages have enabled borrowers to leverage rising home values to support additional purchases. Household debt has surged more than 50% in seven years, and net non-financial private sector credit has exceeded the levels which prevailed ahead of real estate crashes in eighties Japan, nineties Southeast Asia, early-aughts United States, and pre-euro crisis Greece, Portugal and Spain.

Against this backdrop, a rapid Federal Reserve-esque increase in rates would be incredibly dangerous. An abrupt pricking of the debt bubble could derail consumer spending – smashing the financial, construction and retail sectors simultaneously, while pushing the economy into recession. Instead, we think that caution could prevail. While the Bank of Canada has fired a shot across the bow for dovish market participants, a sharp tightening in policy remains a distant prospect, and economic data releases and central bank communications over the coming months could point toward a more modest and prolonged tightening cycle.

If so, the loonie is susceptible to a selloff – with interest rate differentials swinging in its favour, spot rates up sharply, and short positions down dramatically over the past week, any reset of expectations could serve to trigger a whiplash-inducing currency market reversal. As such, we would suggest that hedgers remain alert ahead of Friday’s data release.

Have a great week!


Scheduled Data Releases

00:00    ***       GBP Formal Brexit Negotiations Begin
21:00    **         CNY PBOC Governor Zhou Xiaochuan Speech
21:30    **         AUD Reserve Bank of Australia Meeting Minutes, June


03:30    **         GBP Bank of England, Carney Speech
04:00    *          EUR Euro-Zone Current Account, April
04:45    *          CHF Swiss National Bank Jordan Speech
07:45    *          USD Federal Reserve, Rosengren Speech
08:30    *          USD Current Account Balance, Q1
15:00    *          USD Federal Reserve, Kaplan Speech
19:50    **         JPY Bank of Japan Meeting Minutes, April

02:30    **         JPY Bank of Japan, Kuroda Speech
07:00    *          GBP Bank of England, Haldane Speech
10:30    *          USD Department of Energy, Weekly Inventories
17:00    **         NZD Reserve Bank of New Zealand, Rate Decision

08:30    *          USD Weekly Jobless Claims
08:30    **         CAD Retail Sales, April
10:00    *          EUR Euro-Zone Consumer Confidence, June
10:00    *          USD Federal Reserve, Powell Speech
14:00    *          GBP Bank of England Forbes Speech
14:00    **         MXN Banco de Mexico Monetary Policy Statement

02:45    *          EUR French Gross Domestic Product, Q1
04:00    *          EUR Markit Eurozone Manufacturing Purchasing Manager Indices, June
08:30    ***       CAD Consumer Price Index, May
09:45    *          USD Markit US Manufacturing Purchasing Manager Indices, June
11:15    *          USD Federal Reserve, Bullard Speech
12:40    *          USD Federal Reserve, Mester Speech
13:00    **         USD Baker Hughes Weekly Rig Count
14:15    *          USD Federal Reserve, Powell Speech

Note: Asterisks indicate our preliminary estimate of the potential market impact associated with each event. One asterisk indicates an event with the lowest, two for a moderate impact, and three for the highest expected impact.



Background Reading

Wall Street Journal: Greece: A Case Study in Capital Controls
New Yorker: The Strange Secret History of Operation Goldfinger
Analysis.Org: Tradecraft Primer: Structured Analytic Techniques 
Moneyness: On Currency
New York Times: China’s New Bridges: Rising High, but Buried in Debt
Wall Street Journal: When Currencies Fall, Export Growth Is Supposed to Follow – Until Now
Phys.Org: Fractal Planting Patterns Yield Optimal Harvests
Copenhagen Business School: Designing New Money
The Economist: Lessons from Canada’s Attempts to Curb its House-Price Boom
BBC: How the World’s First Accountants Counted on Cuneiform

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