Morning Commentary: Neighbors to the North

Foreign Exchange - Morning Commentary
Neighbors to the North
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The Bank of Canada (BoC) will announce its latest rate decision tomorrow.  The BoC is widely expected to not only leave rates unchanged at this meeting but also for the next several meetings to come.  

The BoC took quick and decisive action as it swiftly brought its policy rate down to the effective lower bound and launched a large asset purchase program that has pushed the central bank’s balance sheet towards 30% of GDP.  In my view, it is the already accommodative nature of monetary policy and not the economy that is keeping the bank on hold.  However, if the bank feels the need to do more, expect it to come via increased asset purchases rather than rate cuts.  The June 3 BoC meeting also marks the start of the Tiff Macklem era.  Broadly speaking, Gov. Macklem should represent continuity from the previous regime although his past comments do indicate that he is more open to unconventional policies.     

Specifically on the economy, an elongated U recovery remains the most likely path.  The toll on employment has been heavy with the country losing more jobs in March and April than it gained over the past 15 years.  Canada’s jobs report later this week should continue to show weakness in the labor market but at a moderated pace.  High unemployment is a concern for many reasons including the high level of household debt.  Fortunately, the Canadian government has room for increased debt and fiscal stimulus.  

Overall, the BoC’s meeting should not have much of an effect on USDCAD unless the bank upsizes its asset purchases.  Recent price action has seen USDCAD stage a strong move towards CAD strength.  With optimism surrounding economies re-opening, the risk remains for this to continue in the near term; however, a dose of skepticism around this risk rally appears appropriate over the medium term due to the substantial economic risks that remains ahead.  Simply put, Canada likely needs a weaker exchange rate to adjust for the shock delivered to relative growth (vs. the US) and terms of trade (fall in oil prices) this year.  
  • The USD fell to a 3-month low as re-opening economies have hit safe haven demand.  Additional factors that may also be contributing to dollar weakness include a growing national debt and political risks surrounding social unrest.  
  • News reports indicate there may be progress on Brexit talks with the UK softening its stance on regulatory alignment.  However, this softening stance is contingent on the EU also softenening its stance on contentious issues, so today’s positivity might be fleeting.  Technically, the current round of negotiations is the last opportunity to secure an extension before the end of June extension deadline.  
  • The Reserve Bank of Australia kept its policy rate unchanged as expected and struck an opportunistic tone.  While the bank indicated the downturn may not be as deep as initially expected, it also stated that fiscal and monetary support will be needed for some time. 
  • Crude prices are up on the session on hopes that OPEC+ will extend its production cuts.     
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