Wednesday's Bank of Canada interest rate decision is one of the more-intriguing ones this year.
Six things I'm thinking about:
1) What's priced in
The market has priced in a 24% chance of a cut and 90% at the next meeting on June 5.
Most decision this year -- including this week's ECB decision -- have been telegraphed. For 2024, the market has priced in 73 bps.
2) The Bank of Canada isn't afraid to surprise
The Bank of Canada likes to offer markets a steer but if policymakers think it's time to cut or hike, they won't give markets an extra meeting to prepare. Particularly in the Tiff Macklem era, the BOC has done what it felt was needed and that has kept markets off balance. There haven't been enough hints at cuts to justify at 24% probability but the market remembers the history.
3) The market thinks about the divergence with the Fed
Right or wrong, many in the market think that the global easing cycle won't kick off until the Fed signals it. That's particularly true of neighbouring Canada. I think that's wrong and the rate cut by the Swiss National Bank already highlights growing global divergence. Aside from the spillover effects of US growth/inflation, the Bank of Canada isn't using the US to calibrate policy. Yes, they might consider FX effects but those are harder to predict than the textbook says. Yes, the loonie will fall on a rate cut but it would stand to fall further if the BOC was too late to cut and a recession was looming.
4) Housing is top of mind
The Trudeau government is under fire regarding runaway immigration and the cost of housing. Every day there are articles in all the major Canadian newspapers about those topics and the economists at Canada's big banks write about them weekly as well. The Prime Minister is flailing at both issues and looking for solutions as he sinks to oblivion in the pools. That highlights just how critical the issue is and that's seemed into the Bank of Canada as well, where housing/rent inflation is a problem and a slowdown in home-building could seriously hamper GDP.
This is an incredible chart:
5) What does the recent data say?
Key recent indicators:
- Canadian jobs -2.2K vs +25K expected
- Unemployment rate 6.1% vs 5.9% expected
- BOC business outlook survey slightly improved
- Retail sales ex autos +0.5% vs -0.4%
- Feb advance retail sales +0.1%
- CPI y/y 2.8% vs 3.1% exp
- Core CPI 2.1% vs 2.4% prior
Add all this up and you can see why the market has shifted towards the possibility of a cut, particularly Friday's jobs report.
6) What will happen to the Canadian dollar
If you assume the Bank of Canada holds rates this time, the kneejerk reaction will be higher in the loonie but it might not last because there's a very good chance the BOC also includes some strong dovish hints about what's to come in the statement or the press conference. The risk would be that the BOC decides not to offer up any hints and warns that it needs to finish the job on the sticky portions of inflation.
If they cut, it will be straight-forward CAD selling and I'd expect a significant drop. That would lead to a breakout in USD/CAD on the way to 1.38.
