When central banks don't hike interest rates as much as expected, that's generally bad news for a currency and that's exactly what happened in the kneejerk reaction to the Bank of Canada's surprising decision to hike 50 basis points rather than 75 expected.
The US dollar rose a full cent against the loonie initially.
However markets don't always follow the textbook and the Canadian dollar today (or in the near future) could be an example of that.
There are two main reasons why:
1) Domestic risks
The Canadian housing market is at extreme risks regarding higher rates. Unlike in the US, there are no long-term fixed rate mortages in Canada. They're almost all variable or on 5-year fixed resets. Combine that with ultra-high housing prices and the pain from rate hikes hits housing (and household spending) hard.
Currencies like higher bond yields but not when that's combined with rapid economic decay. Canadian 10-year yields are down 17 bps in the aftermath of the decision to 3.32% (compared to US 10s down 7 bps to 4.03% today) so there's a significant spread. But investors in Canada aren't just looking for carry, there's demand for productive investment as well and too-high rates risked a brutal recession. Those risks are lower now and ultimately that will benefit the loonie.
2) Global pivot
This is the main reason why the loonie could turn around. Today's Bank of Canada decision kicks off a series of 6 major central bank decisions in 8 days. The BOC was one of the first major central banks to hike and they're likely just the first of many to slow hikes as well. That shift could come sooner than markets were anticipating just a week ago.
That has a doubly-positive impact for the Canadian dollar. First, it narrows interest rate spreads and puts them back in the Canadian dollar's favor. Secondly, it's positive for global growth. If other central banks ease off the brakes, it means a better outlook for Canadian exports in 2023 and beyond.
