Bank of Canada: Poloz surprises again

BY DEB SHAW | 

  • Poloz keeps the element of surprise, will move "cautiously" on future hikes
  • Growth, policy expectations and sentiment all point to the downside
  • Longer-term weakness dependent on future growth and oil prices

Bank of Canada Governor Poloz likes to keep an element of surprise in his announcements. Following the BoC’s first interest rate hike last summer, many expected the Bank to wait until October for its next rate hike. The upcoming October meeting will include a refresh of the BoC’s Monetary Policy Report – a detailed study of economic conditions, as well as a press conference. Instead, Poloz decided to keep the market on its toes by hiking in September without telegraphing his intentions in advance and without a follow-up press conference.

 

Inflation and currency now in the BoC’s crosshairs

His speech at an event in St. John’s yesterday followed a similar pattern. After having the market believe that the Bank was committed to policy normalization, despite weak inflation and substantial consumer debt, Poloz backtracked in his outlook. Specifically, he said that the BoC is looking to move “cautiously” with regards to future interest rate hikes. He also raised concerns regarding the currency, saying the strength of the Canadian dollar “complicates” future inflation. Future interest rate hikes are expected to be “data dependent”, with inflation being “front and center”.

 

Policy, data and sentiment all point to the downside

With government spending-induced economic growth near a peak, the Bank of Canada backtracking from its commitment to normalize interest rates and stretched speculator sentiment, the outlook for the Canadian dollar is far from rosy.

 

Economic growth near multi-year highs

While Canada amazed the world with its economic growth figures in 2017, a closer look at the data suggests that much of the growth came from the current government’s deficit spending program (specifically, its infrastructure budget). Another issue is that the economy was mired from the after-effects of falling oil prices last year. Thus delivering high rates of year-on-year growth was relatively easier. As the impact of government spending is now fully baked into 2017, high rates of economic growth will be much harder to achieve in the future. A historical perspective of GDP growth is shown below for reference:

Economy likely to roll over, with inflation still below target

9-28-2017 growth inflation
Source: Statistics Canada

 

Canada is unlikely to sustain 4%+ rates of growth in the future, and economic data is likely to weaken from here in rate-of-change terms. Once growth rolls over, the BoC will have few reasons to raise rates with inflation remaining below target.

 

Long loonie is a consensus favorite

Looking at investor sentiment, futures data continues to show that the consensus is long the Canadian dollar. An overview of historical positioning in Canadian dollar futures contracts is shown below:

Speculator sentiment looking stretched

9-28-2017 CFTC
Source: CFTC Futures & Options COT Report

 

With large speculator positions almost two standard deviations above the 1-year average, the Canadian dollar is highly susceptible to a pullback. While extremes in futures positioning do not always foreshadow reversals, the loonie is clearly in the danger zone.

 

What now?

Reflecting back on 2017, the Canadian dollar has benefited this year from higher-than-expected GDP growth, surprise interest rate hikes and a recent resurgence in oil prices. As the continuation of two of the three factors now looks less certain, the path of least resistance for the loonie is to continue weakening. After maintaining a bullish outlook on the currency since last summer, we’ve recently downgraded our outlook on the Canadian dollar in the medium-term to bearish.

Whether or not the current rout turns into long term weakness depends on how these factors evolve. If economic growth slows significantly from here coupled with another oil shock, USD/CAD should have no problem returning to the 1.30s.

Topics: Canadian dollar

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