October BOC Rate Hike Expectations Fall Following Poloz’s Comments

 

Poloz Dampens Rate Hike Expectations

Expectations of an October BOC rate hike have fallen sharply in response to BOC governor Poloz’s speech last week. Poloz expanded on the themes discussed during the September 6^th policy meeting and echoed comments made recently by BOC Dep. Governor Lane.

The Canadian Dollar is now down nearly 200 pips since BOC governor Poloz’s speech last week where he specifically highlighted recent CAD strength and its negative impact on inflation. The governor also reiterated the BOC’s message that the rate path is not pre-determined and that considerable uncertainty clouds the outlook.

BOC Looking to Moderate Market Response

The BOC has been quite careful to highlight that their rate setting is not on a mechanical path and that there is still plenty of discussion and debate around the rate path. This cautious approach is appropriate given the remaining uncertainty in the bank’s outlook around elements such as the evolution of economic capacity, the disinflationary impact of technology, low wage growth and the heightened sensitivity of the economy’s response to interest rate increases given the high level of household debt.

Despite the downward reaction in CAD, the tone of the governor’s message remained constructive overall as he highlighted the completion of the economic adjustment to the oil price shock as well as the closure of the output gap. However, the governor’s caution is clearly part of the BOC’s efforts to moderate the aggressive market response to BOC tightening which has seen a sharp increase in rate hike pricing.

Prior to the speech, OIS had been pricing around one further hike into year end with another by early March 2018. Pricing has now fallen by around 20% for a rate hike into the year end and by around 44% for a rate hike by March 2018. Yield spreads have also been negatively affected, narrowing around 7% on the 2-year curve, on top of the large spread compression which was seen in response to governor Lane’s comments earlier last month.

Speculative Long Positioning At Five-Year Highs

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A large part of the market reaction to Poloz’s comments is a result of the high level of speculative bullish positioning in CAD which had built up prior to the speech. CAD longs had reached five-year highs as traders adjusted their forecasts higher in line with the BOC’s hawkish shift.

USD/CAD rising back above the 1.2450s 2016 low upgrades the prospects for the pair in the short term. Although the move seems a little overcooked relative to yield spreads, USD has been strengthening over recent weeks fuelled by increased expectations of a December rate hike and optimism regarding Trump’s proposed tax reform.

Despite the fall back in expectations following Poloz’s comments, a December BOC rate hike still seems appropriate along with the BOC’s latest MPR forecast of 2% growth in Q3 and improvements in readings such as housing, wholesale and retail trade.

Technical Perspective

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Despite the four-week long recovery, USDCAD is simply retracing within the broad bearish channel running from last year’s highs, having suffered a strong decline over the year so far. The next key resistance will be a test of the 1.2770 August high with the 38.2% retracement from the 2017 high sitting just beneath it.  Above this level and focus will be on the 50% retracement level at 1.2983 with the January 2017 low sitting just above it all.

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Looking at the monthly chart shows that at the double bottom level with the 2016 low, the price put in a large bullish pin bar which is a strong bullish reversal candle suggesting the likelihood of a move higher.