Forming positions in the USD/CAD depending on the outcome of the BoC meeting and negotiations on NAFTA

The US is by no means the only country on the verge of inversion of the yield curve. The large fiscal stimulus from Justin Trudeau and the passing wind from the American tax reform forced the Canadian economy to operate at full capacity. Inflation climbed to 3%, which is the highest in the G7, unemployment wanders near the lowest level in the last four decades, enterprises face a shortage of labor, and GDP in the second quarter accelerated to 2.9%. How does one not continue the cycle of normalizing monetary policy in such conditions?

At present, the futures market expects the fifth overnight increase in October from the middle of 2017, with a probability of 80%. The chances of September raise are much more modest - 20%. In 2019, the derivatives count for three acts of monetary restriction, equivalent to an increase in the rate to 2.25%, after which a long break should follow. Thus, the indicator will not reach a neutral level of 3%, and monetary policy will, as before, be considered to be stimulating. The problem is that the risks of the economy slipping into a recession may slow down the BoC already now.

The difference between long-term and short-term borrowing rates (yield curve) is inexorably moving toward the red zone. The spread between 30 and 10-year securities has already fallen there, between 10 and 2-year olds is at the lowest levels since 2007. If we consider the American experience, then during the last half century the inversion quite accurately predicted a decline. However, the latest study by the Fed says that the best signals are given by the yield differential of 10-year and 3-month bonds.

Dynamics of Canada's GDP and yield curve

Source: Bloomberg.

What does the ratio of the yield curve have to do with the Canadian dollar rate? As in the case of its American counterpart, the fall of the indicator towards the red zone strengthens the positions of the Bank of Canada doves and may move the timing of the next overnight rate increase to a later date, which is a bearish factor for the loonie. Expectations of the continuation of the cycle of normalization of monetary policy made this currency the second best performer of G10 in the last 3 months. If you deprive it of an important trump card, everything will go awry. Talks about the BoC's desire to slow down arose after Stephen Poloz's statement in Jackson Hole that the acceleration of inflation is temporary. And this is not the only problem of the USD/CAD bears. 

 

Donald Trump threatens to throw Canada out of NAFTA if Ottawa does not sign the agreement on terms favorable to the US. After the breakthrough in the relations of Mexico and the US, many investors believed that adding a third party to the contract is a matter of technique. In practice, everything turned out differently, the negotiations were put on hold until September 6, and the loonie again came under pressure. Geopolitical risks continue to cut its wings. This circumstance increases the risks of growth USD/CAD in the direction of 1.31-1.315, especially if the BoC at its meeting appears dovish. At the same time, the base scenario assumes that Canada will still remain in NAFTA, which allows us to recommend to sell the pair on growth.

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Price chart of USDCAD in real time mode

Canadian dollar got a sun stroke

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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