Our 2020 outlook centred on the idea that USDCAD would break the $1.30 level on a structural basis given the assumption that external headwinds would subdue somewhat in the New Year, thus keeping the Bank of Canada on hold.
While the pair broke the psychological barrier in the early part of January due to rising geopolitical tensions in the Middle East and its ensuing impact on oil markets, USDCAD has since resumed trading above $1.30 leaving the base case intact.
Further clout has been added to our view after the US and China signed the narrow trade deal last week.
Although this truce could potentially break down and reignite the trade war, the time frame of China’s purchasing agreements suggests that this isn’t necessarily a short-term risk and thus reduces the external headwinds that almost forced the Bank of Canada into an insurance rate cut.
|13:30 GMT||New Housing Price Index||0% YoY|
|13:30 GMT||CPI Inflation||2.2% YoY|
|15:00 GMT||Bank of Canada rate decision||1.75%|
|16:15 GMT||Poloz press conference|
|13:30 GMT||Retail Sales||-1.2% MoM|
Recent economic data has also developed in line with expectations. Inflation pressures remain firm, slack in the labour market has predominantly dissipated, however output growth remains weak.
Goldman Sachs’ Current Activity Indicator (CAI) suggests growth in Q4 2019 was substantially lower than where it tracked throughout the whole year.
The winter Business Outlook Survey was a net positive report despite the collation of results occurring prior to the US-China trade deal.
The survey highlighted a slight improvement in business sentiment, rising hiring intentions, broadening capacity pressures but declining investment expectations.
Meanwhile, the first release of the Consumer Finances Survey evidenced well anchored inflation expectations along with rising expectations for consumer spending and house price growth.
The only minor blip in the data thus far came in the form of slowing wage growth in December. The hourly permanent employees wage figure fell from 4.4% to 3.8% in December, however much of this can be attributed to base effects. In nominal terms, the labour market actually reversed some of November’s negative surprise by adding 35,200 jobs – roughly half of the prior month’s labour market contraction.
Taken together, the progression of conditions thus far in 2020 has confirmed our prior belief that an insurance rate cut by the Bank of Canada was predominantly conditioned on no US-China trade deal being reached in Q1 2020.
With this out of the way, economic conditions suggest the BoC are likely to remain on pause throughout 2020 barring any unexpected shocks, with risks tilted to further monetary tightening – although the probability of a rate hike is limited and skewed to the back end of the year.
Chart: Current data releases point to a sharp decline in Canada’s Q4 GDP, the only blemish in economic conditions
Next week’s BoC rate decision is arguably a highly predictable event for that reason. The reduction in external risk coupled with inflation sitting at cycle highs, expectations of renewed house price growth, and higher consumer confidence will likely result in the central bank taking a more laissez-faire approach to the year than suggested in Q4 2019.
Pricing in swap markets suggests the probability of a rate change now favours a rate hike in January’s meeting for the first time since early October, albeit with a miniscule probability.
Outside of the Bank of Canada’s rate decision, the release of November’s retail sales report will provide interesting reading on how high wage growth filters through into consumption.
October’s report of a 1.2% contraction undershot market expectations dramatically. Investors will keep a close eye on the report to see whether October’s negative surprise was generated by transitory events that impacted vehicle and building material sales or whether the consumer is showing signs of fatigue.
Chart: Swap markets have retreated from pricing an insurance rate cut by the BoC to being net hawkish