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Canadian Dollar: CIBC Capital Initiate a Sell Ahead of BoC


Above: BoC Governor Macklem. Image © Bank of Canada, Reproduced Under CC Licensing

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CIBC Capital Markets are looking to sell the Canadian Dollar into the Bank of Canada meeting, due on October 27.

The strategic play comes as the Canadian Dollar sits atop its G10 peers having outperformed all in 2021, but "risks are incredibly skewed" heading into the midweek meeting says Bipan Rai at CIBC Capital.

Rai, who is the bank's North American Head of FX Strategy, says skewed downside risks are a symptom of the market becoming too confident on the Canadian economy's outlook relative to the Bank of Canada's (BoC) own assessment.

The market is priced for as many as four interest rate hikes to come out of the BoC, with the first falling in April 2022.

Expectations for rate hikes are built on the assumption that Canadian inflation rates are to push materially higher alongside robust economic growth and a supportive global backdrop.

For CAD exchange rates to be maintained at around current levels the BoC must on Wednesday deliver a tone and guidance that reflects robust expectations for the economy, in turn maintaining market expectations for notably tighter monetary conditions in Canada.

"Despite the improvement in domestic employment, it's going to be incredibly difficult for the Bank to justify that profile for policy tightening," says Rai.

Canadian Dollar sits atop the pile

Above: CAD has outperformed all G10 peers in 2021.

Economists at CIBC anticipate the BoC to lower growth forecasts in light of the -1.1% result for the second quarter.

Recall, the July MPR had +2.0% forecast for that quarter.

The third quarter is meanwhile looking to come in closer to just half of what the BoC's forecast for +7.3%.

"The net result is that guidance around when the output gap closes is likely to change somewhat. Instead of closing in H2 2022, watch for the Bank to alter the language in a dovish manner ("later in H2 2022"). This is important because the Bank's forward guidance clearly ties rate hikes to when economic slack is fully absorbed," says Rai.

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The market anticipates the BoC to announce a further reduction its quantitative easing programme to C$1BN / week, a precursor to the programme's completion and eventual rate hikes.

Investors will however be keen to hear the BoC's view on whether or not the BoC has entered a "reinvestment phase", which is the point at which the BoC purchases enough bonds to replace those that inevitably mature.

This is essentially a 'neutral' state of play for quantitative easing.

Rai suggests a subtle change in forward guidance should help to push back against "egregious pricing" in Canadian interest rate future markets (known as BAX contracts).

"Indeed, a corrective move in BAXs post-BoC this week should be consistent with a weaker CAD," says Rai.

CIBC are looking to go 'long' on USD/CAD with a potential target located at 1.2575.

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