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CAD looks undervalued; BoC expresses inflation concerns

CAD looks undervalued; BoC expresses inflation concerns

  • The CAD was beaten up, even more, this past week as risk appetite remained shaky, crude oil prices struggled to find direction, and, most importantly, short-term US-Canada rate spreads contracted dramatically, reaching levels not seen since early October.
  • Markets were clearly worried — perhaps a little more than we realized — that the Bank of Canada's policy mandate review might derail the central bank's tightening path. Although the renewed mandate allows the Bank of Canada to set policy more flexibly to promote job growth, Governor Macklem reasserted the bank's inflation-fighting credentials mid-week, emphasizing that the flexibility would not apply in current circumstances and would only be used when the economy is weak, or inflation is low. Despite the CAD's recovery since mid-week, fair value models suggest that spot FX should be trading around 1.2645 against the greenback a full 200 basis points lower than current levels.
  • Most analysts remain optimistic about the CAD's long-term prospects. The hawkish undertone to Governor Macklem's remarks stated he was not satisfied with the current level of inflation and that the moment was drawing closer for policymakers to shift away from forward guidance—suggests rate hikes could be coming even sooner - possibly as early as January.

The week ahead:

  • Currently, markets are pricing a full rate hike by April 2022, through the early part of next year, the BoC announcements are scheduled for January 26, March 2, and April 13. Although the run-up to Christmas isn't usually quiet, the calendar is comparatively light. The week ahead should be relatively calm with the USD/CAD trading on broad market themes and Omicron headlines.

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