USD/CAD: BOC begets big bearish reversal
January 20, 2016 10:20 AM
<p>Heading into today’s big BOC decision, it felt like USD/CAD bears just needed to get put out of their misery. After all, the Canadian dollar had lost 11% of its value against the US dollar in last three months alone, to say nothing of the larger move from sub-parity levels in USD/CAD less than three years ago. Of course, the proximate cause of the weakness has been the renewed drop in oil prices, Canada’s most important export. The economic impact of the collapse in oil prices cannot be understated: it has impacted nearly every aspect of the Canadian economy, from employment to manufacturing activity to inflation to consumer confidence. </p>
Heading into today’s big BOC decision, it felt like USD/CAD bears just needed to get put out of their misery. After all, the Canadian dollar had lost 11% of its value against the US dollar in last three months alone, to say nothing of the larger move from sub-parity levels in USD/CAD less than three years ago. Of course, the proximate cause of the weakness has been the renewed drop in oil prices, Canada’s most important export. The economic impact of the collapse in oil prices cannot be understated: it has impacted nearly every aspect of the Canadian economy, from employment to manufacturing activity to inflation to consumer confidence.
For loonie traders though, today’s big question was "Will the Bank of Canada cut interest rates in response, or will it merely hint at a future interest rate cut?" As it turns out, the BOC’s answer was "neither." Not only did BOC Governor Poloz and company leave interest rates unchanged at 0.50%, they also issued a relatively neutral monetary policy statement at the same time. Selected highlights of the BOC’s accompanying statement can be seen below [emphasis mine]:
- Inflation evolving broadly as expected
- Expects inflation will rise to about 2 per cent by early 2017
- China continues transition to a more sustainable growth path
- Expansion in the United States is on track, despite temporary weakness in the fourth quarter of 2015
- Prices for oil and other commodities have declined further, represents a setback for the Canadian economy
- GDP growth likely stalled in the fourth quarter of 2015
- Economy's return to above-potential growth to be delayed until the second quarter of 2016
- Process of reorientation towards non-resource activity is underway, helped by stronger U.S. demand, the lower Canadian dollar, and accommodative monetary and financial conditions
- Projects Canada's economy will grow by about 1 1/2 per cent in 2016 and 2 1/2 per cent in 2017
- Risks to the profile for inflation are roughly balanced
- Financial vulnerabilities continue to edge higher
While this is by no means a singularly optimistic assessment of the Canadian economy, it is far less dovish than most traders had anticipated. Reading between the lines, the BOC seems to expect that the beneficial impact of the falling loonie on the non-oil sectors of the economy, as well as upcoming fiscal stimulus, will soften the economic blow of falling oil prices. We’re skeptical of this Pollyannaish view, but Governor Poloz is taking the stage to defend the statement as we go to press, so traders should closely monitor his tone during the press conference to handicap what the BOC may do next.
Technical view: USD/CAD
On a technical basis, the interest rate decision and neutral statement have predictably led to an immediate drop in USD/CAD. The pair has shed over 125 pips from pre-BOC levels as of writing, and considering the big rally over the last few weeks and overbought RSI indicator, a deeper pullback cannot be ruled out. To the downside, the key levels to watch will include the 20-day MA around 1.4150 and the key 1.40 level. While we could see a near-term pullback from today’s BOC decision, loonie bulls need to see oil prices stabilize before a more meaningful rally can form. Therefore, we wouldn’t be surprised to see USD/CAD back pressing its decade-plus highs sooner rather than later if oil prices remain subdued.
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