From Bank of America Merrill Lynch
BAML on the BOC:
Firmly on hold, we believe.
Despite faltering growth and anemic hiring, we expect the Bank of Canada to remain on hold at their September policy meeting. This meeting will not include a Monetary Policy Report or press conference, so we think the BoC will likely keep the message simple.
There are three important points to keep in mind:
First, the drop in 2Q GDP was expected. The BoC's 2Q forecast was -1.0% in anticipation of drag from forest fires. Although the data have come in weaker than expected with evidence that sectors outside of energy were soft, we still expect the BoC to largely shrug this off as noise.
Second, although weak growth suggests more slack in the economy, the BoC has frequently trimmed their estimate of potential growth during periods of declining capex. Thus, we assume the BoC will not get too hung up on precisely measuring how much slack has been generated in 2Q.
Third, housing imbalances remain on the BoC's mind. But it sees monetary policy as a last line of defense, so we do not expect any hawkish signals. Add it all up and this meeting should be a bit of a snoozer.
Eventual upside for USD-CAD
With a BoC likely on hold and a Fed potentially hiking at the end of the year, USDCAD should see some upside over the rest of the year, in our view. Despite the importance of the core oil fundamental for CAD as a commodity currency, the key shifting factor has been the renewed importance of rate differentials for Canada on both sides of the border. In general, rates have become a renewed source of importance for CAD movements since the crisis.
However, this year, policy differentials as expressed through rate differentials became that much more important given the appearance at the beginning of the year that the Bank of Canada was about to cut 25bp to 0.25%, which of course would have caused markets to contemplate the next move to unconventional measures at the zero lower bound or a move into quantitative easing. The new Canadian government's decision for fiscal easing in the spring also took off pressure from the BoC to ease, also taking a weight off the currency.
Of course, rates have not always been a key driver, and had been stagnant for a while after the crisis. But when we include both rate differentials and oil prices in standard regression models, we see USDCAD being more fairly valued in the lower-to-mid 1.30s.
Consequently, given our overall market call of expecting a Fed rate hike eventually this year and some near-term oil weakness, we still look for some further USD upside over the rest of the year. As in many places in our FX outlook, the key difference between our forecasts and the market is our expectations of a moderately more hawkish Fed.
For USD/CAD in particular, the recent stalling in non-energy export growth is likely to help give the BoC pause. Still, we likely need to see the market price in a more sustained path of Fed hikes to knock us from the market's current complacency. Otherwise, CAD may be range bound, caught between the tug of war of commodity valuation and still divergent monetary policies.
