The loonie has struggled and the next few weeks won’t be any better
BoC’s Policy Announcement
Most observers expected the Bank of Canada to raise interest rates by 25 basis points last week; while a hike in the Overnight Target Rate was not fully priced into the markets (70-75 percent), market expectations had evolved to the point where a move would not have come as a surprise. The policy position remained unaltered but was followed by a hawkish statement that stated that excess capacity in the economy had been eliminated. Governor Macklem stated that last week's meeting was a significant turning point in the monetary policy cycle and that a series of rate hikes could be forthcoming. The FOMC also kept policy unchanged, and Chairman Powell also stated that rates will need to rise soon. In essence, both central banks assured investors that interest rates will begin to rise in March, but they left the door open for further rate hikes.
Canada is still expected to raise rates a little quicker than the Fed
The delayed start to the BoC tightening cycle and markets pricing in quicker Fed hikes have narrowed spreads against the CAD; the 2Y differential narrowed to –5bps from –25bps ahead of the BoC decision. The USD's 5Y spreads have also re-entered positive territory. Market analysts anticipate that in the coming weeks, spreads will become more CAD-friendly; the Bank of Canada is still expected to raise rates a bit ahead of and a little quicker than the Fed. We have a little more faith in the Bank of Canada to deliver on the expected level of tightening to return monetary policy to neutral.
USD/CAD medium-term forecast
In the long run, we remain bullish on the CAD, but the next few weeks may be a rocky ride for the currency. The CAD's direction will be determined by a three-way tug of war between yields (spreads), commodities, and risk appetite. We expect commodity prices to remain well-supported and help underpin the CAD. Energy (crude oil) trends are optimistic, and the price of oil might easily rise above $90 in the near future.
Despite political concerns about rising energy prices, constrained supplies and strong economic growth are keeping prices high. In the immediate term, risk appetite could be the largest threat to the CAD, as higher US rates could cause further turbulence in equity markets. Geopolitical risks might affect the CAD in both positive and negative ways; the situation in Ukraine could exacerbate negative risk sentiment while also causing metals and energy prices to rise.
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