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The Canadian Dollar Slides after BoC Appears to Condition Future Hikes Upon U.S.-China Detente

Image © Bank of Canada 

- CAD softens as BoC statement, oil prices, risk aversion weigh.
- BoC cheers signs of CA recovery but reiterates 'neutral' stance.
- Trade war developments are now key to the interest rate outlook.

The Canadian Dollar was on its back foot Wednesday as oil prices declined in a risk-averse market and after the Bank of Canada (BoC) appeared to suggest it could be quite some time before it lifts interest rates again, even if the domestic economic outlook has improved notably of late. 

BoC policymakers left the cash rate unchanged at 1.75%  for the month on Wednesday, while Governor Stephen Poloz issued a surprisingly upbeat assessment of the recent Canadian economic performance and current outlook. 

"Recent Canadian economic data are in line with the projections in the Bank’s April Monetary Policy Report (MPR), with accumulating evidence that the slowdown in late 2018 and early 2019 is being followed by a pickup starting in the second quarter," Poloz says, in a BoC statement.

Canada's economy grew at a meagre annualised pace of 0.4% in the final quarter of 2018 and the BoC has forecast that it will have expanded by only 0.3% in the opening quarter of 2019, largely due to past events in the oil market that saw prices decline by 30% late last year. 

Poloz noted signs of a recovery in the Canadian oil sector, which is key to both GDP growth and the currency given that oil is the nation's largest export, and also cheered a more "stable" outlook for the housing market.

"The statement doesn't explicitly warn of rate hikes to come (that remains data dependent), but has an optimistic tone about what lies ahead, leaving the impression that the Bank sees the next move as a hike, if well down the road.  We're surprised at the initial market reaction," says Avery Shenfeld, chief economist at CIBC Capital Markets

The BoC's upbeat tone was not without merit this Wednesday, not least of all because the U.S. has lifted tariffs on imports of Canadian steel and aluminium, which some say will aid the ratification of the USMCA trade agreement. 

Canada's labour market has also performed strongly too, with employment growing at its fastest pace since 2010 during the April month. And the Brent oil price has risen 28% so far in 2019, marking a reversal of all the losses wracked up in the fourth quarter of 2018. 

Furthermore, the BoC says it expects all of Canada's various measures of inflation to remain around the 2% target over the coming months, which when combined with expectations of a pickup in economic growth might normally have been enough to get financial markets betting on an interest rate rise.

"Despite the optimistic tone of the statement, the loonie has continued to struggle today and actually briefly traded lower on the release. Market expectations of BoC policy are at rock bottom," says Ranko Berich, head of market analysis at Monex Europe

The rub for the Canadian Dollar might be in the bank's guidance on future interest rate moves, as it said clearly that future policy decisions will be dependent on developments in the domestic economy and that it will pay particular attention to "developments in household spending, oil markets and the global trade environment."

That could mean that interest rates are unlikely to rise for quite some time so far as the market is concerned because the tariff fight between the U.S. and China is now on the verge of morphing into an all-out economic conflict. 

There is now a consensus among analysts and economists that both the U.S. and China are preparing themselves for a protracted conflict that blights the global economic landscape for a while yet. 

Above: USD/CAD rate shown at daily intervals. 

"The loonie continues to respect the boundaries of the key 1.3520 pivot level," says Mark McCormick, head of FX strategy at TD Securities. "We look to reload on USDCAD longs around 1.3350." 

The USD/CAD rate was 0.22% higher at 1.3520 following the release Wednesday but has fallen 0.54% this year, while the Pound-to-Canadian-Dollar rate was 0.11% higher 1.7094 but has declined 1.7% in 2019.

"We think the GBP break of support at 1.73 last week and the slide below the base of the rising channel in place since Oct point to more weakness ahead. Trend oscillators are aligned bearishly—if weakly—for the GBP and monthly price action is shaping up to be especially bearish for the GBP," warns Eric Theoret, a technical analyst at Scotiabank.

Above: Pound-to-Canadian-Dollar rate shown at daily intervals.

If the BoC is reluctant to lift its interest rate the entire time the global economy is operating underneath a cloud of uncertainty thrown up by the trade war, the market may have taken the view on Wednesday that Canadian interest rates are going nowhere fast no matter what the GDP numbers say in the short-term. 

The BoC about-turned in April on earlier guidance that suggested it could lift its interest rate as many as four times in 2019. Its guidance now is that rates could go up or down in the next change, making for a 'neutral' stance.

It cited a slowing global economy, weakness in the domestic economy and risks to already-low business confidence given the ongoing 'trade war' between the U.S. and China as well as an absence of progress across the border on ratifying the new North American Free Trade Agreement (USMCA).

Markets will be attempting to gauge over the coming months if it will be happy to retain this newfound neutral stance, or if it might soon begin considering a further shift to the kind of so-called 'easing bias' recently adopted by the central banks of New Zealand and Australia.

In this regard, developments on the trade front will be key. 

After all, the U.S.-China trade war has escalated dramatically since President Donald Trump lifted from 10% to 25% tarifs charged on imports of $200 bn of goods from China and began threatening a further $300 bn of annual trade.

The tariff fight between the world's two largest economies is also on the verge of becoming an all-out economic conflict after President Trump 'blacklisted' the Chinese telecoms and technology giant Huawei and a number of its affiliates. 

This has led many global counterparts to cut ties with the embattled firm and drew threats of retaliation from China. Governor Poloz has consistently cited this trade issue as the BoC's most pressing concern for the economic outlook.

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