Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Bank of Canada Preview: More Cuts on the Horizon
Charu Chanana
Chief Investment Strategist
Key points:
- The Bank of Canada is expected to cut rates by 25bps to 4.50% at the July meeting, following its initial rate cut in June.
- June inflation undershot projections and retail sales also declined. Labor market conditions have worsened, but persistent wage pressures may mean a more balanced statement remains likely.
- The rate differential between the BoC and the Fed is widening, potentially making the CAD more vulnerable. However, upcoming US political developments and market expectations of Federal Reserve actions could also impact the CAD’s performance.
The Bank of Canada (BoC) is expected to continue its path of normalizing rates with a possible 25bps cut to 4.50% at the upcoming July policy meeting after it kickstarted the rate cut cycle in June.
The BoC had emphasized a cautious, data-dependent approach following its June rate cut. With June inflation easing and unemployment rising, a second consecutive rate cut in July appears likely. Concurrently, the Federal Reserve seems closer to starting its own rate cut cycle amid broadening US economic data weakness. The BOC also has a historical tendency for consecutive moves at the start of a cycle, reinforcing the likelihood of another cut this month.
Economic Backdrop Offers Easing Excuse
- Inflation: The June inflation print undershot expectations to come in at 2.7% YoY vs. BOC’s 2.9% projection, supporting the case for further easing. Core inflation did not slow as anticipated but also did not increase compared to May, suggesting it may not significantly hinder additional cuts.
- Retail Sales: May retail sales fell by 0.8% MoM and the April print was also revised lower, indicating that consumer spending may drag on second-quarter GDP.
- Business Outlook: The Q2 Business Outlook Survey suggests firms expect continued easing of inflation pressures, with improvements in capacity constraints and labor shortages.
- Labor Market: Labor market conditions worsened in May and June, with total payroll growth in June declining by 1.4k and the unemployment rate rising to 6.4% from 6.2%. Persistent services inflation and stronger wage growth may receive closer scrutiny during the BoC’s deliberations.
Other Considerations
- Policy Divergence to the Fed: The BoC’s policy rate is already 75bps below the Fed funds rate, and another cut would widen this gap to 100bps, the largest since 2006. This could make the CAD vulnerable, though expectations of Federal Reserve easing in September may alleviate some of this concern.
- US Politics Could Strengthen USD: The increasing probability of a Trump 2.0 presidency and aggressive fiscal policies may drive demand for the US dollar, potentially pressuring CAD. However, markets are unwinding the Trump Trade to some extent with President Biden stepping away from the race.
Potential Impact on CAD
Overall, while there may be reasons for the BOC to cut rates again, the statement could turn slightly less dovish and more balanced to reflect the momentum in June core inflation and continued wage pressures. This could mean that a data-dependent approach is emphasized and the central bank could remain away from committing to further rate cuts.
- Short-Term: If the BoC delivers a rate cut accompanied by a balanced statement, the CAD may experience limited decline. The market is also pricing in a September Fed rate cut which could put the US dollar on the backfoot. However, a dovish statement with clear indications of further rate cuts could lead to a more pronounced decline in the CAD.
- Medium-Term: The Fed-BOC rate differential would continue to argue for a weaker CAD. However, US politics will gather increasing focus in the months ahead. If protectionism related to a potential Trump victory is priced in, the CAD might be less vulnerable compared to other high-beta currencies like the AUD, given the Canadian economy is likely less vulnerable to protectionist policies. Conversely, if Kamala Harris gains traction in polls, the CAD might underperform as focus turns back to rate differentials and rising hard landing risks in the Canadian economy.
Disclaimer:
Forex, or FX, involves trading one currency such as the US dollar or Euro for another at an agreed exchange rate. While the forex market is the world’s largest market with round-the-clock trading, it is highly speculative, and you should understand the risks involved.
FX are complex instruments and come with a high risk of losing money rapidly due to leverage. 65% of retail investor accounts lose money when trading FX with this provider. You should consider whether you understand how FX work and whether you can afford to take the high risk of losing your money.
Recent FX articles and podcasts:
- 16 Jul: JPY: Trump Trade Could Bring More Weakness
- 11 Jul: AUD and GBP: Potential winners of cyclical US dollar weakness
- 3 Jul: Yuan vs. Yen vs. Franc: Shifting Carry Trade Strategies
- 2 Jul: Quarterly Outlook: Risk-on currencies to surge against havens
- 26 Jun: AUD, CAD: Inflation Rising, Can Central Banks Stay on Pause?
- 21 Jun: JPY: Three-Way Pressure Piling Up
- 20 Jun: CNH: China Authorities Loosening their Grip, But Devaluation Unlikely
- 19 Jun: CHF: Temporary Haven Flows Unlikely to Fuel SNB Rate Cut
- 18 Jun: GBP: UK CPI Details and Elections Will Keep BOE on Hold
- 13 Jun: BOJ Preview: Tapering and Rate Hike Talk Not Enough to Boost JPY
- 10 Jun: EUR: Election jitters and ECB rate cut add to downside pressures
Recent Macro articles and podcasts:
- 22 Jul: Biden Out, Harris In: Markets Reassess US Presidential Race and the Trump Trade
- 8 Jul: Macro Podcast: What a French election upset means for the Euro
- 4 Jul: Special Podcast: Quarterly Outlook - Sandcastle economics
- 1 Jul: Macro Podcast: Politics are taking over macro
- 28 Jun: UK Elections: Markets May Be Too Complacent
- 24 Jun: Macro Podcast: Is it time to diversify your portfolio?
- 12 Jun: France Election Turmoil: European Equities Amidst the Upheaval
- 11 Jun: US CPI and Fed Previews: Delays, but Dovish
- 10 Jun: Macro Podcast: Nonfarm payroll shatters expectations - how will the Fed react?
- 3 Jun: Macro Podcast: It is a rate cut week
Weekly FX Chartbooks:
- 22 Jul: Weekly FX Chartbook: Election Volatility and Tech Earnings Take Centre Stage
- 15 Jul: Weekly FX Chartbook: September Rate Cuts and the Rising Trump Trade
- 8 Jul: Weekly FX Chartbook: Focus Shifting Back to Rate Cuts
- 1 Jul: Weekly FX Chartbook: Politics Still the Key Theme in Markets
- 24 Jun: Weekly FX Chartbook: US Presidential Debate is the Big Market Unknown
- 10 Jun: Weekly FX Chartbook: US CPI and FOMC dot plot have a low dovish bar
- 3 Jun: Weekly FX Chartbook: ECB and Bank of Canada likely to cut rates
FX 101 Series:
- 15 May: Understanding carry trades in the forex market
- 19 Apr: Using FX for portfolio diversification
- 28 Feb: Navigating Japanese equities: Strategies for hedging JPY exposure
- 8 Feb: USD Smile and portfolio impacts from King Dollar
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