Bank of Canada must grapple with a long list of worries
Key facts:
The Bank of Canada benchmark overnight rate is 1.25%
Rates were left unchanged at the April 18 meeting (full text)
There is no MPR or press conference, just a statement
The decision is at 10 am ET (1400 GMT)
Canadian dollar traders feel like they're at the centre of a storm at the moment. The currency is the nexus of volatility in oil, trade, risk appetite and central bank uncertainty. The BOC can offer some clarity on one front but isn't much help on the others.
In the past few weeks, the odds of a hike at this meeting have dwindled to 16% from 50% in mid-April. The global backdrop is part of the shift but it's mostly about soft economic data. April CPI was a tad soft while retail sales ex-autos were down 0.2% compared to a +0.5% reading expected. Those numbers two weeks ago tipped the balance and there has been nothing to halt it.
Could the BOC surprise?
It's extremely unlikely. They faced major blowback for botching the communication on a pair of hikes last year and they went on the defensive afterwards, suggesting they don't want to go down that path again. The residual 16% chance of a hike that remains in the market reflects some of the distrust that was built up after those episodes but I think it overstates the real probability, which I would put at less than 5%.
If it were to happen, there would be a sharp immediate rise in the Canadian dollar and corresponding drop in USD/CAD by as much as 200 pips with more or less depending on the communication.
One interesting caveat is that the first look at Q1 GDP is due on Thursday -- the day after the decision. BOC policymakers will almost-certainly get an early look at the numbers, which are expected to show q/q annualized GDP at +1.9% in the quarter, a slight uptick from 1.7% in Q4. Economists expectations range from 1.4% to 2.5% and it's tough to imagine anything within a range making any difference to the BOC. The 2018 BOC forecast is for 2.0% in the first half of the year and 2.5% in Q2, so the risks are to the downside but policymakers will see anything in the +1.7% range as close enough for now.
GDP, however, may present a tradable opportunity. Expect some commentary in the text of the BOC on near-term growth. This will likely be a clue GDP with a quick trade on Thursday's headlines as a possible way to exploit it.
Another event to watch on Thursday is a speech from BOC Deputy Governor Sylvain Leduc in Quebec at 12:50 ET. The BOC rolls out speakers after its statements to tweak the message when needed.
Three things to watch in the statement text
The BOC statement should be viewed less as guidance and more as an opportunity for the BOC to direct the market's focus on certain incoming data points but that transition is a work in progress. For now, the market will continue to try to find a signal.
1) Watch the final line
The "Governing Council will remain cautious with respect to future policy adjustments, guided by incoming data," is the key line. Really, the key word is 'cautious'. Objectively, it should be a signal that rates won't be moving at the next meeting and that's how it was interpreted when it first appeared but Poloz later went to great lengths to make it clear that wasn't the case. So maybe it's meaningless or just means the BOC won't hike back-to-back when a hike comes. But if it's removed it will be seen is a sign that a hike is coming at the July 11 meeting, which is currently priced at a 53% chance of a hike.
2) What data is the BOC watching?
The recent statement highlighted inflation and wage growth along with the economy's sensitivity to interest rates. Aside from commodity-inflation, there hasn't been any sign of acceleration in prices while there has been more trepidation in housing, which might mean the economy is more-sensitive to higher rates. The BOC said in the prior statement that some of the weakness in housing early in the year will be unwound. They might be losing confidence in that belief.
3) Exports
Canadian terms of trade continue to deteriorate even as oil prices rise. The April merchandise trade deficit hit a record. The BOC will undoubtedly be comforted by the government's plan to build the Transmountain Pipeline but that's many months from relieving the oil glut. The bigger problem is NAFTA and that's something the BOC has repeatedly fretted about. The most recent statement said: "Exports and investment are being held back by ongoing competitiveness challenges and uncertainty about trade policies." If anything, uncertainty about NAFTA is higher than it was six weeks ago with no end to talks in sight.
Bottom line
In April, the Bank of Canada statement was surprisingly optimistic but data and developments in trade and the global economy since have been negative. Expect a tentative statement with no hint of a hike in July but still leaving the door open if the data improves. The knee-jerk is likely to send the Canadian dollar lower. Afterwards, the focus will quickly shift back to Italy and oil. Technically, there isn't much standing in the way of a return to 1.31.
