The Canadian Dollar could see heavy volatility in the week ahead as a flux in risk sentiment is compounded by an interest rate decision from the Bank of Canada.
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[B]Canadian Dollar Volatility Ahead on Rate Decision, Risk Trends[/B][/B]
[B]Fundamental Forecast for Canadian Dollar: [/B][B]Bearish[/B]
- Canadian Economy Shrinks More than Expected in the Second Quarter
- Employment Unexpectedly Rises On Surge in Part-time Hires
The Canadian Dollar could see heavy volatility in the week ahead as a flux in risk sentiment is compounded by an interest rate decision from the Bank of Canada. An actual change in benchmark borrowing costs is effectively off the table – the BOC has explicitly expressed the intent to keep rates at 0.25% at least through the first half of next year. The markets are in agreement, with overnight index swaps showing that traders are pricing in virtually no change in rates this time around. Whether or not the news proves market-moving will depend on the bank’s rhetoric vis-à-vis the Canadian Dollar in the statement accompanying the monetary policy announcement. BOC Governor Mark Carney has said that the currency’s appreciation over recent months has been a major obstacle for economic growth, adding that he has the “flexibility” to deal with it. Finance Minister Jim Flaherty echoed Carney’s comments, saying “steps could be taken” to check the currency’s ascent. It should not be too difficult for policymakers to make good on such threats because they can simply print more money and let it loose into circulation, so the markets have little reason not to take any language suggesting intervention at face value. To that effect, traders will likely sell the Canadian Dollar should the likelihood of such an outcome be perceived as increasingly likely. An intermediate before an outright move to sell the domestic currency into the market may be to extend the commitment to keep rates on hold deeper into next year. While the effectiveness of such a move in the long term is uncertain, it is likely to amount to losses for the Canadian Dollar in the aftermath of the announcement.
The Canadian Dollar’s sensitivity to changes in risk sentiment is well documented, and any meaningful reversal here could prove to weigh heavily on the currency. Trading volumes have steadily declined for the last five of the six-month equity rally that began in March. While some of this can surely be attributed to a seasonal slowdown that is typical for the summer months, it may also be hinting at waning conviction behind the up move and forthcoming reversal as traders return from holiday and volumes pick up in September. Further, the safety-linked US Dollar yielded the smallest percent change in two years last week despite ample catalysts for volatility, not the least of which was Friday’s Nonfarm Payrolls report, suggesting uncertainty about where to go from here and leaving the door open for a trend change. We have long held that the markets did too much, too fast: global equities finished August trading at levels unseen since 2003 relative to earnings; the world economy grew nearly 3% in real terms that year, whereas virtually every credible forecast calls for the first post-WWII contraction in real growth in 2009, pointing to lackluster revenues and overdone equity markets. Technical positioning looks conducive to a reversal lower, with the MSCI World Stock Index showing clear negative divergence with momentum indicators. The Canadian Dollar’s average trade-weighted value is now 94.7% correlated with the MSCI metric, suggesting any downturn in share prices will bring the currency along for the ride.