Will Canadian CPI Push USD/CAD To Parity On Wednesday?

SEP 19
Headline CPI (YoY) (AUG) (07:00 EST; 11:00 GMT)
Bank ofCanada Core CPI (YoY) (AUG) (07:00 EST; 11:00 GMT)

Expected: 2.1%
Expected: 2.2%

Previous: 2.2%
Previous: 2.3%

How Will The Markets React?
Inflation pressures in Canada are anticipated to have eased somewhat during the month of August, as headline CPI is expected to fallen to an annualized rate of 2.1 percent from 2.2 percent. Furthermore, the Bank of Canada’s core CPI measure - the figure they use in their monetary policy decisions - is estimated to have edged down to 2.2 percent from 2.3 percent. The news should help quell the concerns of inflation hawks, as the Bank of Canada continued to cite “significant” risks to the inflation outlook. However, downside risks to growth and recent volatility in the financial markets, which has taken a particularly harsh toll on Canadian commercial paper markets, has led the markets to believe that the central bank doesn’t have much room to take rates any higher. Indeed, Bank of Canada Deputy Governor Pierre Duguay recently said, “given recent events in global credit markets, we need to assess the extent to which the risks around our July projections have shifted." This sentiment was only exacerbated by the Federal Reserve’s sharper-than-expected rate cut on September 18th. On the other hand, the unemployment rate held at a 33-year low of 6.0 percent in August, creating the potential for increased consumption and tighter capacity. Furthermore, crude oil has continued to rocket to record highs above $80/bbl while other commodities gain as well. Given these upside inflation risks, the Bank of Canada is anticipated to raise interest rates once again in early 2008. Nevertheless, if we see an easing in CPI upon release on Wednesday morning, traders will remain focused on the downside risks and price in a neutral stance by the central bank.
Bonds - 10-Year Canadian Government Bond Futures
Canadian government bond futures have held their uptrend and remain contained to an ascending channel, despite wild price action following the Federal Reserve’s sharper-than-expected rate cut on Tuesday. With respect to the trend, CGBs are likely to continue higher to target 113.29. On the other hand, a break of trendline support at 112.29 could signal a change of pace for the contract. The release of Canadian CPI on Wednesday adds a good amount of event risk, as a weaker-than-expected reading could lead to speculation that the Bank of Canada will follow the lead of the Fed and cut rates. Such an interpretation could lead CGBs rocketing higher, while signs that price pressures remain relatively strong could drive the contract for a test of support.

The Canadian dollar has shown a powerful bout of strength in recent days, as USDCAD makes a mad dash for 1.0000 as the pair barrels through fresh 30-year lows. While this has generally been the result of significant weakness in the US Dollar throughout the forex markets (EURUSD has hit record highs of 1.3987), the sharp decline in USDCAD is very hard to ignore. However, the pair is very close to encountering trendline support at 1.0100, and while the strength (or weakness) of the greenback will likely play a greater role in where the pair goes next, Canadian CPI could play a part as well. For example, if CPI is significantly softer-than-expected, speculation may mount that the Bank of Canada will follow the Federal Reserve’s lead and cut rates this year. This could easily turn USDCAD higher to recoup some of the pair’s gains. On the other hand, a CPI reading in line with expectations is unlikely to shake the pair up, and with oil prices remaining remarkably high, Loonie could remain supported and USDCAD could soon go in for a test of 1.0000.

Equities - S&P/TSX Composite Index
Canadian equities followed Wall Street higher on Tuesday, as the S&P/TSX Composite Index ended the day just above the psychologically important 14,000 level. More gains could be in store for the index, especially if Canadian CPI is softer-than-expected and leaves traders to consider the possibility that the Bank of Canada will follow the Federal Reserve’s lead and cut rates this year. While this is actually very unlikely, the overall bullish sentiment of the equity markets could be enough on its own to push the S&P/TSX to test the 78.6 percent retracement level of 14,646.82 - 12,463.78 at 14,180.

Written by Terri Belkas, Currency Analyst for DailyFX.com