Fx flash boc to resume easing cycle 27 sept 2016

FX Flash

Group Economics

Macro & Financial Markets 50 Research 40 30 20 27 September 2016 10 0 -10 -20 -30  Jan-10 CanadianJan-11 dollar under pressure as rateJan-14 cut speculation Jan-12 Jan-13 Jan-15 increase Jan-16

BoC to resume easing cycle?

Roy Teo

 In our view, a rate cut in in full 2016 is jobs unlikely Change time '000 3mth avg (rhs)

Senior FX Strategist Tel: +65 6597 8616

 Upside risk to 2016 year end USD/CAD forecast of 1.27 Change in labor force '000 3mth avg (lhs)

roy.teo@sg.abnamro.com

Canadian dollar under pressure as rate cut speculation increase Since last Friday (23 September), the Canadian dollar (CAD) has been out of favour, declining by 2 cents to above 1.32 against the US dollar. This was triggered by surprisingly weak inflation print in August. Core inflation eased lower from 2.1% to 1.8% last month, the lowest level since July 2014. A combination of slower economic activity in the second quarter and deterioration in labour market contributed to lower inflationary pressures. Indeed average hourly earnings of permanent workers plunged to 1.6%yoy in August, the lowest wage growth since June 2014. As a result market speculation that the Bank of Canada (BoC) will resume its easing cycle has increased.

Core inflation and wage growth have declined

Risk of a rate cut in Canada has increased recently

%

Probability of 25bp rate cut %

4

60 50

3

40 2

30 20

1 10 0 Jan-10

0 Apr-11

Jul-12

Oct-13

Average hourly earnings YoY% Source: Statistics Canada

Jan-15

Apr-16

Dec-16

Core CPI YoY%

Mar-17

Jun-17 22-Sep

Sep-17

Dec-17

26-Sep

Source: Bloomberg

A rate cut in 2016 is unlikely In our view, the BoC is unlikely to cut policy rates this year despite downside risks to their exports and inflation forecast. In the last monetary policy statement in September, the BoC’s view is that the economy is likely to rebound in the third quarter as oil production recovers, rebuilding commences in Alberta and consumer spending gets an additional lift from Canada Child Benefit payments. Federal

Insights.abnamro.nl/en

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FX Flash - BoC to resume easing cycle? - 27 September 2016

infrastructure spending is also expected to have a larger impact with economic growth projected to remain above potential in the last quarter of this year. Hence it is premature for the central bank to resume its monetary easing cycle in the coming months. While we note that monetary conditions have deteriorated recently, current levels still do not warrant looser monetary policy. Last but not least, BoC governor Poloz has recently said that policy makers may need to tolerate a wider range of price swings or allow more time to recover from a shock, which may take as long as 3 to 5 years for an economy to restructure itself.

Monetary conditions do not warrant a rate cut yet Monetary conditions index

4 2 0 -2 -4 -6 -8 -10 -12 Jan-10

Non-commercial positions remain net positive %

1.25

1.00 0.75 0.50 0.25

0.00 Jul-11

Jan-13

Monetary conditions (lhs) Source: Bank of Canada

Jul-14

Number of contracts

140000 120000 100000 80000 60000 40000 20000 0 Jan-11

Jan-16

Apr-12

Jul-13

Oct-14

Jan-16

CFTC non-commercial long CAD futures positions

Overnight lending rate % (rhs)

CFTC non-commercial short CAD futures positions Source: CFTC

Upside risk to 2016 year end USD/CAD forecast of 1.27 Ahead of the next monetary policy meeting on 19 October, sentiment in the CAD is likely to remain weak. Data from the CFTC shows that speculators’ positioning remain net positive. Hence an unwinding of long positions could weigh on the CAD. Indeed the options market demand to hedge against a weaker CAD has also increased in recent weeks. According to data from the Depository Trust and Clearing Corporation, there are large option strikes around 1.33 expiring this week. Hence in the absence of a sharp recovery in crude oil prices, the CAD is likely to edge towards key support level of around 1.3285 against the US dollar in the coming days. Given our view that crude oil prices are likely to rebound to USD 65 per barrel by the end of this year, we remain hesitant to downgrade our CAD forecast. Nevertheless, we acknowledge that there is an increasing risk that the CAD will be weaker than our year end forecast of 1.27 against the US dollar.

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FX Flash - BoC to resume easing cycle? - 27 September 2016

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FX Flash - BoC to resume easing cycle? - 27 September 2016