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- CAD pares gain over USD, cedes more ground to GBP, after GDP miss.
- Feb GDP contraction vindicates BoC's pessimistic 0.3% forecast for Q1.
- Morgan Stanley a seller of USDCAD as Scotiabank eyes stable GBPCAD.
The Canadian Dollar wobbled while trading on its front foot against many rivals Tuesday after official data revealed a surprise February contraction in the economy, vindicating the Bank of Canada (BoC) for its anaemic estimate of growth for the first-quarter overall.
Canadian GDP fell by -0.1% in February, Statistics Canada says in an statement Tuesday, when markets had been looking for an unchanged 0% reading to follow on from the 0.3% growth seen back in January.
All 20 industrial sectors of the economy were evenly balanced between gains and losses in February, although when all is said and done, output from both goods and services producing industries declined during the month.
The biggest falls in output were seen in the mining, oil, and gas extraction industries as well as the transportation and warehousing industries, although the financial services and manufacturing industries also experienced losses.
"The surprise versus consensus showed up partially in mining, oil & gas, but after looking at the details that appears to have had nothing to do with oil production cuts. It was actually a broad-based decline in mining and quarrying attributed to weaker international demand that drove that sector," says Royce Mendes, an economist at CIBC Capital Markets.
Above: Contributions to Canadian GDP in February. Source: Statistics Canada.
Markets have been preoccupied in recent months with a narrative that suggests the global economy continued to slow rapidly early in the New Year, although first-quarter GDP figures from both the U.S. and Eurozone have begged to differ with that idea.
U.S. growth was far stronger than any economist had dared to imagine, which could have positive implications for the Loonie, and the Eurozone economy also saw growth pickup faster-than-expected when just a few weeks ago the European Central Bank (ECB) told markets that economic weakness likely carried over into the New year.
The mismatch between expectations and outcomes of the U.S. and Eurozone data could be said to suggest scope for a positive surprise from Canada for the first quarter, although that certainly wasn't forthcoming Tuesday. The Bank of Canada (BoC) slashed its forecast for first-quarter growth to just 0.3% last week.
"Today's miss will take tracking forecasts of the Canadian economy below 1% for Q1, closer in line with the Bank of Canada's downbeat projection. Given that the miss came from two volatile sectors, however, market reaction could prove somewhat limited," says Mendes.
Above: Contributions to Canadian GDP in number format. Source: RBC Capital Markets.
Currency markets care about the GDP data because it reflects rising and falling demand within an economy, which has a direct bearing on consumer price inflation, which is itself important for questions around interest rates. And interest rates themselves are a raison d'être for most moves in exchange rates.
Canadian GDP growth nearly halved in 2018, falling from 3% previously to just 1.8% last year, after an economic slowdown took hold in the second-half. That was mostly the result of a -30% final quarter fall in oil prices and after concerns over the impact the U.S.-China trade war would have on the global economy stymied Canadian activity.
"Wintry weather had a negative impact, though growth wouldn’t have been much better than flat without that factor. Today’s softer-than-expected GDP report leaves Q1 growth tracking somewhere between our 1.2% forecast and the BoC’s 0.3% call, which looked pessimistic when it was unveiled last week," says Josh Nye, an economist at RBC Capital Markets.
Nye and RBC's forecast suggests next month's figure could be substantially ahead of that seen Tuesday, which might be enough to have markets take another look at the new interest rate guidance provided by the BoC last week which has since prompted investors to bet there's some chance of an interest rate cut coming before year-end.
Above: USD/CAD rate shown at daily intervals.
"The outlook for relative central bank policy is dominating and yield spreads are narrowing in a CAD-supportive manner as domestic rate expectations remain steady while Fed expectations soften into Wednesday’s FOMC," says Shaun Osborne, chief FX strategist at Scotiabank. "The market tone remains constructive and oil prices are also appear to be stabilizing. Our FV estimate (using the 2Y and 5Y spread, as well as WTI) is currently at 1.3381."
The USD/CAD rate was quoted -0.04% lower at 1.3451 following the release Tuesday, after paring an earlier -0.10% fall, and is now down just -1.12% for 2019.
The Pound-to-Canadian-Dollar rate was 0.73% higher at 1.7527 and is up 0.72% this year.
"GBPCAD pushed through, but failed to hold above, short-term trend resistance off the March high yesterday, leaving the GBP trapped between the 40-day moving-average (1.7525) and strong support at 1.7300/20. The cross has essentially traded in a tight range around 1.74 over the past month after falling sharply (and developing a strong, bearish signal) around the turn of the month through Feb/Mar—and that flat trend might continue for now," says Eric Theoret, a technical analyst at Scotiabank, in a Friday note to clients.
Above: Pound-to-Canadian-Dollar rate shown at daily intervals.
Pricing in the overnight-index-swap market implied on Tuesday, a December 04, 2019 Canadian cash rate of just 1.63%, which is far below the current rate of 1.75%. Some analysts say that implies a 40% probability of an interest rate cut coming before year-end.
This was after the BoC abandoned last week, the 'tightening bias' that would have seen it go on lifting interest rates over the coming quarters, potentially taking th ecash rate up to 2.5% this year.
The BoC says the outlook means the economy still needs an interest rate that is below the so-called 'neutral' range where monetary policy is neither restrictive nor stimulative, which is why it adopted a 'neutral bias' last week. This means interest rates could go either up or down in the next change.
That was part of a u-turn by the BoC on earlier forward guidance, which suggested in October that rates could rise as many as three times in 2019. And even though markets were expecting some form of negative message Wednesday, the Canadian Dollar was still hurt by the BoC's announcement.
But despite all of that some are actively betting on a steep fall in the USD/CAD rate over the coming months, including the currency team at Morgan Stanley.
"The outlook for crude oil continues to be positive as OPEC+ supply cuts continue to impact the market and global demand rises. A rebound in growth in China and Europe would support this further," says Hans Redeker, Morgan's head of FX strategy. "The BoC sounded dovish in April, but stronger economic data could surprise a market positioned heavily against CAD."
Redeker wrote to clients weeks ago telling them to wait for USD/CAD to hit 1.35 before betting on a fall all the way back to 1.29 during the summer months. That trade was activated this week in the aftermath of the BoC sell-off.
"Should global growth continue to stabilize and rebound, financial conditions stay loose,and US growth remain relatively supported, the BoC may once again discuss the need to get rates back to neutral. A risk to the trade is that global crude prices begin to fall," Redeker writes, in a note to clients.
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