Canada has really set itself apart from its southern neighbor in terms of its economy lately. While the FOMC Fed meeting is only just getting around to cutting rates, Canada’s slow economic growth has left prices rising at a much slower rate. The BOC has turned to cutting in an effort to prop up the economy, and might have to ease even more if things don’t improve.
Tuesday’s inflation figures will be pivotal for markets looking to figure out just how much easing the BOC will do. Though the trajectory of the USDCAD might be determined more by what happens at the FOMC Fed meeting on Wednesday, the Canadian side of the equation is just as important. All of this comes in the context of the main coalition partner in Prime Minister Justin Trudeau’s government deciding to chart its own course, raising the chances of a confidence vote that could usher in a general election.
Clearing Up the Uncertainty
Markets don’t like not being able to figure out where things are going. Which gives the Canadian dollar a bit of an advantage, since all the uncertainties generally point down. It’s only a matter of how much, which has allowed the markets to probability price in a lot of the downside going into the data release. As a result, the Loonie has been able to retain its position while other currencies have trended lower in recent days.
A week ago, Canada reported the highest jobless rate in seven years, hitting 6.6%. This puts Canada in the same range as Europe, which is mired in economic stagnation. As a measure of comparison, the Euro Area has an interest rate of 3.5% following the most recent cut. The BOC last left interest at 4.25%, implying that there is a broader gap to close given the economic similarities. This is in contrast to the US, which still has rates at a multi-year high, but unemployment at 4.2%.
The Twin Weights
The Loonie has another problem: Canada’s largest export is oil, meaning that if crude prices decline, its currency would be under pressure. At the same time, lower crude prices translates into lower inflation inside the country. Initially lower energy prices just affect the headline rate, but cheaper energy and transportation costs eventually filter into the core rate. This gives a double effect on the Canadian dollar when the price of crude has significant moves.
Add to that the BOC being inclined to cut, the Canadian dollar is set up for generally trending lower. Just last week, Bank of Canada Governor Tiff Macklem said that faster rate cuts might be necessary if the economy doesn’t improve. He also warned that increasing trade conflicts could hurt central banks’ ability to fight inflationary pressures.
Preparing for the Surprise
With these factors being taken into consideration by markets, the bias is likely to be the downside. Meaning that if inflation is lower than expected, the market is more likely to take it in stride. But a surprise beat in the data might end up shaking the market more, and lift the CAD. At least briefly in the interim until the Fed rate decision.
Headline July Canadian inflation is expected to tick down to 2.4% from 2.5% prior, with fuel prices seen as the largest contributor. But the BOC’s favorite inflation measure, the trimmed mean rate, is expected to decline by a similar amount to 2.6% from 2.7% prior.