For the first time this year, the CAD declined sharply against the US dollar, closing above 1.2550 on Friday. While the loonie has outperformed most of its G10 counterparts so far this year, the BoC and the Fed's policy choices this week will have a substantial impact on the currencies' path in the short term. The stock market had a rough week, with high-tech firms and "pandemic upstarts" under heavy pressure as investors re-position ahead of the FOMC meeting. The US is not expected to make any interest rate moves this week, but policymakers are likely to disclose additional information about the breadth of prospective policy decisions this year, as well as plans to shrink the Fed's balance sheet. Expect the Fed to wait until March to hike rates, as the tapering process is expected to be completed by then. According to the latest prediction revisions from the major banks, the US should see a total of 175 basis points of tightening this year.
Last week, the Bank of Canada's rate forecast was upgraded, with 175 basis points of tightening expected in Canada this year, bringing the Overnight Target Rate to 2.00 percent by year's end. According to some market observers, the first tightening will occur this week, with rate hikes leading the Fed overall this year, maintaining a slight disparity between Canadian and US rates. This will be beneficial to the Canadian dollar, there are strong indications that the USD/CAD could hit 1.20 later this year.
BoC rate hike scenarios:
Market pricing suggests a high level of confidence that the Bank of Canada will raise interest rates on Wednesday, but this is not a foregone conclusion (roughly 70 percent probability of a hike). Concerns about Omicron could put policymakers on the fence, but a delay in raising rates this week should be accompanied by a hawkish policy statement that lays the framework for a raise in March (perhaps 50bps). USD/CAD could extend towards 1.24 in a "hawkish hike" scenario.
Given what is priced in and how far rate expectations have shifted, a "dovish hike"—that is, a tightening followed by a policy statement indicating patience on the timing of subsequent rate increases tightening—is likely the largest risk for the CAD this week. USD/CAD gains could extend until the mid-1.26s in this scenario.
This week’s USD/CAD currency forecast:
This week’s trading range will be difficult to predict with the BoC rate decision driving direction of the currency in the near term. This week’s range – 1.24 (BoC “hawkish hike”) - 1.27 (BoC “dovish hike”)
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