Bank of Canada caught between hot economy and cold NAFTA
Rumours surrounded this week going from shrinking Chinese appetite of U.S. bonds to speculation that the United States would pull out of NAFTA and while real economic indicators on Friday showed stronger U.S. inflation and retail sales it did little for the struggling US dollar. Economic growth outside of the US is accelerating and monetary policy is expected to tighten more abroad putting pressure on the greenback.
The euro/U.S. dollar (EUR/USD) currency pair gained 1.43% during the week. The single currency is trading at 1.22 a three-year high after German Chancellor Angela Merkel announced a coalition ending the uncertainty after the elections three months ago. After a marathon session lasting 24 hours the old grand coalition is back with the Christian Democrats (CDU), the Christian Social Union (CSU) and the Social Democrats (SPD) ready to bring the band back together. The Social Democrats changed their minds after refusing to take part in another coalition, but with a fruitless attempt by Merkel to form a government failed, the SPD is now saying it wants to hold German society together.
The euro has been strengthened by the European Central Bank (ECB) meeting minutes released earlier this week. Economic growth in the EU is encouraging and the central bank seems ready to end its quantitative easing (QE) program and raise rates, although the timelines still extend beyond 2018. The fact that the ECB is serious about tightening monetary policy based on growth has put pressure on the dollar as the euro continues the trend seen at the end of last year.
The Fed’s Eric Rosengreen is confident that there could be as many as four rate hikes to the US benchmark rate in 2018. The Boston Fed President expects the recent tax cuts to boost the economy and reduce unemployment. Rosengreen also joined others at the Fed in moving away from having a fixed inflation target preferring a range which would give the policymakers more flexibility. The divide between members worried about low inflation and those who want to keep raising rates to avoid the economy overheating.
The USD economic calendar will be quiet as the Martin Luther King holiday on Monday will shorten the week. The biggest release of the week will be the release of building permits in the United States on Thursday, Jan. 18, at 8:30 am EST.
European data will also be scarce with final consumer price index (CPI) data due on Wednesday, Jan.17 at 5:00 am EST and German Bundesbank President due to speak on Thursday at 3:00 am EST the highlights of the weekly calendar.
The U.S. dollar/Canadian dollar (USD/CAD) currency pair gained 0.36% in the last five days. The currency pair is trading at 1.2462 after the loonie was able to recover some ground on Friday ahead of the Bank of Canada (BoC) monetary policy decision on Jan. 17. Two back to back strong employment reports and other positive economic indicators could convince the central bank to raise the benchmark interest rate by 25 basis points to 1.25%. Almost all Canadian banks have put higher rates as their prediction with the lone stand out the number 7 bank Laurentian who is not joining the crowd.
The BoC could justify the move based on strong fundamentals but it has also ignored them in the past, specifically the beginning of last year where strong GDP growth and stable oil prices forced the central bank to hike twice. The July hike was heavily telegraphed, but the September decision took the market by surprise as the market was expecting the move a month later.
The bank has gone from over communicating to staying mum in quick succession, adding to the uncertainty of what decision it will reach on Canadian interest rates on Jan. 17. Market expectation is one thing, but BoC Stephen Poloz could show a more patient stance. Headwinds have been scarce, but the reports of Canadian officials anonymously sharing their opinions about the increasing odds of NAFTA’s demise did not favors to the loonie. The CAD has risen on strong economic indicators and is almost up 1% against the USD year to date. The Bank of Canada (BoC) could hike on Jan 17, while analysts do not expect the U.S. Federal Reserve to follow suit until March, when Jerome Powell makes his first official appearance as Chair.
The Bank of Canada (BoC) will publish its rate statement on Wednesday, Jan. 17 at 10:00 am EST. The forecast calls for a rate rise of 25 basis points. BoC Governor Poloz will host a press conference at 11:15 am EST.