News & Analysis

With Canadian CPI out of the way, the loonie looks towards the Federal Reserve later today.

The decision over US monetary policy could force the Bank of Canada into an “insurance” rate cut, however, this is an unlikely scenario at the current time.

Today’s inflation data was overlooked by the loonie this morning. The average of the core-CPI measures the Bank of Canada uses continued their recent trend of sitting around the 2% target, while the headline number dipped to 1.9% YoY – predominantly due to the lower price in fuel.

The data added little extra information over the state of the Canadian economy and the loonie quickly reverted to trading off of global macro and geopolitical events.

As oil prices stabilise following the latest Saudi commentary stating production will revert back to full capacity by the end of the month, the loonie will line up its focus to tonight’s Fed meeting.

Following the heightened attention towards the US repo market and the availability of USD liquidity, expectations have turned increasingly more dovish.

The Federal Reserve could strike a 50 basis point cut this afternoon, although this is unlikely, in an attempt to regain control of short-term interest rates and relinquish the New York Fed from Open Market Operations.

Should the Fed embark on such a cut, not only would it provide some stabilisation to the monetary policy transmission into the real economy, but it would also flip yield spreads and put downward pressure on USDCAD.

 

Chart: Muted reaction in USDCAD following stable CPI release

A strong loonie is a problem for the Bank of Canada as inflationary pressures are already plentiful and the economy remains strong but fragile to external conditions.

The Federal Reserve could alternatively embark on a mini-QE program, which many pundits have placed as the likeliest solution until a standing repo facility is introduced.

Increased USD liquidity via an increase in the Fed’s balance sheet will also have appreciation repercussions for the Canadian dollar, but will arguably be more dulled than that of a 50 basis point rate cut.

The forward guidance on growth and interest rates is also key, with both likely to be revised downwards, but given the publicity the US money market has received this week, markets will likely focus on the Feds response to liquidity shortages.

 

Author: Simon Harvey, FX Market Analyst at Monex Europe.