The Canadian Dollar Stages Riposte against Rivals after Poloz Signals July BoC Meeting is Still "Live"

-Canadian Dollar advances after Poloz keeps hopes of July hike alive.

-BoC won't set rates according to "trade war" speculation or rumours.

-USD/CAD biased higher as strategists eye another test of 1.35 level.

© Bank of Canada

The Canadian Dollar entered the Thursday session on the front foot, staging a riposte against the developed world currency basket, after Bank of Canada governor Stephen Poloz dispatched market fears that an escalating global "trade war" might keep it from raising interest rates on July 11.

Following a speech about central bank communications, Poloz told reporters the BoC will not conduct monetary policy based on "rumours or speculation", suggesting it will not allow itself to be stymied from raising interest rates by speculation in the press and jitters in financial markets over President Donald Trump's trade policies.

The so called "trade war" between the US, China and more recently, the European Union, has been a hot button issue for all financial markets in recent months but particularly for currencies and the Canadian Dollar. So Poloz having said fears over what tariffs or restrictive legislation might emerge from the White House next is positive for the Loonie.

"The Governor struck a much more constructive tone at the press conference, reiterating that the economy was close to home, stating business investment had been reasonably robust, and declaring that the Bank would not respond at all to political rhetoric," says Mark McCormick, North American head of FX strategy at Toronto-based TD Securities.

But there was also a dovish bent in the speech and subsequent statements that left some strategists with the impression the BoC could yet eschew a rate hike in two week's time.

On this note, Poloz said the Bank is attempting to model the likely impact that trade uncertainty and new mortgage regulations will have on the Canadian economy and inflation, which are both highly important for its interest rate decisions.

"He did note that both the steel/aluminum tariffs and the new mortgage rules will "figure prominently in our upcoming deliberations", a dovish comment, but at the same time he said that "financial markets understood our message" in reference to the more confident assessment of growth in their May statement (and presumably what that implied for the timing of the next tightening)," says Avery Shenfeld, chief economist at Toronto-based CIBC Capital Markets.

President Trump is pursuing restrictive legislation to govern Chinese investments into the United States and has recently ordered that a range of tariffs be levied against imports of more than $250 billion in American imports of Chinese goods.

The move has drawn retaliation and threats of even further reciprocal measures from the Chinese, which all comes on top of earlier White House tariffs on imports of steel and aluminium into the United States from across the globe, including the European Union. The EU has since responded to those with its own levies on US motorcycles, jeans and whiskey, drawing threats of even more tariffs from the White House, this time targeting the mighty European automotive sector.

All of these hostilities on the international trade front matter for the Loonie because Canada is also in the firing line when it comes to trade relations with its southern neighbour. Officials from both sides of the border have been attempting, without success, to renegotiate the North American Free Trade Agreement for nearly a year now.

Above: USD/CAD rate shown at daily intervals.

The USD/CAD rate was quoted 0.40% lower at 1.3277 during the London morning Thursday but is up 5.5% in 2018. The Pound-to-Canadian-Dollar rate was 0.52% lower at 1.7395 but is up 2.7% this year.

Above: Pound-to-Canadian-Dollar rate shown at daily intervals.
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July Rate Hike is Still a Go

Earlier in June President Trump hit out at Canadian Prime Minister Justin Trudeau on Twitter, attacking Canada's high tariff rates on US dairy products and accusing the nation's ministers of having taken advantage of the US for "too long".

Fears are that the US will simply withdraw from NAFTA if it cannot secure new terms that are more agreeable to the White House, which TD Securities has previously said could lead to slower economic growth, lower interest rates for a longer period and a double-digit fall in the Canadian Dollar.

"Odds of a July rate hike by the Bank of Canada are now essentially a coin flip after sitting at nearly 80% in mid-June. Lower rate expectations are due in part to an escalation in trade uncertainty and some disappointment on the data front. Despite this, our view for a July hike remains unchanged, consistent with incoming data and past BoC communications," says Brittany Bauman, a macro strategist at TD Securities, in a note Wednesday.

Markets are looking for the Bank of Canada to raise its interest rate on July 11, which would take the cash rate up to 1.5% and mark the BoC's fourth hike in the last 12 months. However, confidence in whether the BoC will actually go ahead and pull the trigger has ebbed during recent weeks given the increased uncertainty about the international trade environment.

Pricing in overnight index swaps markets, which enable investors to protect themselves against changes in interest rates and also provide insight into expectations for monetary policy, implies a Canadian cash rate of 1.38% on July 11. This suggests around a 56% probability of a rate rise in two week's time, but is down from the 1.44% implied rate prevailing at the start of June.

Changes in interest rates, or hints of them being in the cards, are only made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"The Governor will indeed want to see Friday's GDP data, the next employment report, and any fresh news on the trade front before making up his mind. Add it all up, and it seems that Poloz, like the market, may be for now on the fence for a July hike. We'll stick to our call that rates will indeed rise in July, but its a close one, and that's consistent with our long held view that July's move would be the last one for this year," says CIBC's Shenfeld.


But Monday to Throw CAD another Curveball 

The Bank of Canada signalled in May that it will raise interest rates next month when it tweaked some of the language in its previous interest rate statement, although since then Canadian inflation has surprised on the downside and risks to the economy are seen as having risen given the aggressive White House trade policy.

"The Bank incorporates some drag from trade policy uncertainty on business investment and exports but is generally reluctant to incorporate changes in policy until measures are implemented," Bauman adds.

Last month the White House extended tariffs on imports of steel and aluminium to include those coming from Canada, drawing retaliatory measures from Ottawa that are due to come into effect on July 01. It has since also hinted that it could use a section 232 investigation under the Trade Expansion Act 1962 in order to raise tariffs on imports of cars into the US.

TD's Bauman notes that it took President Trump "only a few hours" to threaten tariffs on the European automotive sector after the EU announced its own levies on American motorcycles on June 22 and warns there is a risk that Canada's retaliation to the White House metal tariffs could draw similar response when the tariffs come into force on Monday, 02 July.

This would be bad news for the Canadian Dollar and may support the TD Securities FX team's call that the USD/CAD rate will soon challenge the 1.35 barrier again, taking its total 2018 loss to more than 7%.

"Disentangling NAFTA risks and the outlook for the BoC is as close as it gets to being stuck between a rock and a hard place," says TD's McCormick, in another note this week. "The recent move in USDCAD over the past month is fully explained by the model so the rally has been matched by deteriorated fundamentals. New (negative) information leaves room for the pair to push higher. We have no qualms about a return to 1.35 before reassessing spot's risk/return profile."

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