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Market Wire:
Loonie Buffeted by BOC’s Dovish Lean

Don Curren July 10, 2019

The loonie was buffeted by turbulence Wednesday morning, initially gaining altitude after rhetoric from Fed Chair Jerome Powell reinforced expectations of an impending rate cut in the US, but then suffering an abrupt descent when the Bank of Canada’s policy statement took a more dovish tone than expected.

The net effect was that the Canadian dollar was little changed on the day after the Bank’s statement.

The Bank maintained its overnight target at 1.75%, where it’s been since last October 2018, and the accompanying policy statement made no nod to easier policy, but it did acknowledge that the domestic outlook is clouded by persistent trade tensions.

“Evidence has been accumulating that ongoing trade tensions are having a material effect on the global economic outlook,” the Bank’s statement said. “Trade conflicts between the United States and China, in particular, are curbing manufacturing activity and business investment and pushing down commodity prices.”

The statement said the Bank believes the Canadian economy is returning to potential growth, but emphasized that the domestic outlook is clouded by persistent trade tensions.

“Taken together, the degree of accommodation being provided by the current policy interest rate remains appropriate,” it said. “As Governing Council continues to monitor incoming data, it will pay particular attention to developments in the energy sector and the impact of trade conflicts on the prospects for Canadian growth and inflation.”

The statement acknowledged that exports rebounded in the second quarter “and will grow moderately as foreign demand continues to expand.”

“However, ongoing trade conflicts and competitiveness challenges are dampening the outlook for trade and investment,” it said.

The Bank projects real GDP growth to average 1.3% in 2019, up from 1.2% in its January Monetary Policy Report, and about 2% in 2020 and 2021.

South of the border, US Federal Reserve Chair Jerome Powell began an address to the Committee on Financial Services, U.S. House of Representatives, Washington, at 10 am EDT.

In the text of his opening statement released earlier Wednesday, Powell said, “inflation has been running below the Federal Open Market Committee’s (FOMC) symmetric 2% objective, and crosscurrents, such as trade tensions and concerns about global growth, have been weighing on economic activity and the outlook.” His remarks were interpreted as signaling a strong likelihood of an interest rate cut after the Fed’s next policy meeting on July 30-31.

The Bank of Canada is faced with an escalating tension between two conflicting factors – the Fed’s apparent lean to a more accommodative policy stance and the string of solid economic data that militate against the BOC following it US counterpart down that path.

As of Tuesday, Canada’s overnight-indexed swaps market was pricing in a 7.8% probability of a cut by the Bank’s next policy date on Sept. 4 and 23.5% odds of a cut by the last meeting of the year on Dec. 4. The equivalent market in the US was pricing in a 100% probability of a cut from the Fed at its next policy meeting.

Bottom Line: Despite the Canadian dollar’s wobble on Wednesday after a more dovish-than-expected policy statement, expectations that interest rates in the US are headed lower while Canada’s remain relatively static over the longer term could propel further the loonie higher at a time when the country’s non-energy export sector is struggling to expand on a sustained basis and take a larger role in economic growth.

Don Curren
Market Strategist and Content Editor
dcurren@cambridgefx.com
@dbcurren

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