Loonie Rebound a Brewing Problem for BoC – BMO CM
Benjamin Reitzes, Senior Economist at BMO Capital Markets, notes that
the loonie has rebounded with gusto since hitting its weakest level in
13 years in January, bouncing about 16%.
“The combination of rising oil prices and a persistently dovish Fed has provided significant support to the formerly beleaguered currency. Indeed, the U.S. dollar has been broadly weaker driven by falling Treasury yields. Friday’s strong Canadian CPI and retail prints certainly didn’t hurt the loonie either. While Canadians coast to coast will benefit from lower-priced imported goods and less expensive vacations to the U.S., the Bank of Canada will be much more concerned about the detrimental impact on exporters.
Recall that despite upgrading its growth forecast, the BoC sounded quite dovish last week, and that tone was echoed in Poloz’s appearances this week before the House and Senate. The dovishness was driven by concerns about the softer global backdrop and firmer Canadian dollar. Interestingly, the policy statement noted firstly that “shifting expectations for monetary policy” were benefitting the loonie, while commodities seemed to have a secondary role.
We’d agree, as it’s clear that the loonie has outrun the gains in oil based on their historical relationship. There’s no denying that Canada-U.S. interest rate spreads have narrowed massively, providing big-time support to the currency. Until the Fed takes a more hawkish turn (not certain that’s going to happen given the recent U.S. data), the U.S. dollar and Treasury yields aren’t likely to gain much traction.
The other possibility is for the BoC to turn decidedly more dovish if the C$ strengthens too much. We suspect a move through C$1.25 (or 80 US cents) would prompt a decidedly more dovish tilt. While we believe the risks for the balance of the year remain skewed toward a rate cut (even if the odds are small), markets are actually pricing in no move or small rate-hike odds after Friday’s solid data.
Don’t be surprised if Poloz’s appearance next week tries to back markets off their slow shift to pricing in hikes. One wrinkle from this week’s Senate testimony was that it might take “more than three years” for Canada to recover from the oil shock. That doesn’t sound like a man ready to tighten policy any time soon.”