Canadian Dollar extends rally in aftermath of BoC interest rate decision, softer US inflation

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• Canadian Dollar continues rallying against the US Dollar on Thursday after the BoC’s decision to raise rates at its meeting on the previous day. 

• The Bank of Canada cited Canada’s robust economic growth as the main reason for raising rates as it fears inflationary forces building. 

• Data released on Thursday shows a slowdown in the rise in US factory gate prices which further pushes USD/CAD lower.

Canadian Dollar (CAD) continues rising versus the US Dollar (USD), on Thursday, in the aftermath of the Bank of Canada’s (BoC) decision to raise interest rates by 0.25% and its open-ended, data-driven approach to forward guidance. A slowdown in factory gate inflation in the US as revealed by Producer Price Index (PPI) data for June, further speeds the pair’s sell-off as it confirms the slowing US inflation narrative, and suggest peak rate may be close at hand. 

USD/CAD is trading in the 1.31s during the US session.  

Canadian Dollar news and market movers 

• The Canadian Dollar trades higher against the US Dollar on Thursday after the US Bureau of Labor Statistics releases PPI data for June, and the results come out lower than expected. The softer inflation data supports the narrative initiated by Wednesday’s Consumer Price Index data miss. 

• The data backs up the market’s view that the Federal Reserve may only raise rates one more time in 2023, according to the CME FedWatch Tool, which calculates probabilities of future rate decisions based on the price of Fed Funds Futures. Since higher rates are bullish for currencies because they attract more foreign capital inflows, the suggestion the Fed may be ‘one and done’ is weighing on the USD (thus negative for USD/CAD).

• US PPI dropped to 0.1% from 0.9% YoY, falling way below estimates of 0.4%. On a monthly basis they rose by 0.1% which though higher than May’s -0.4% was nevertheless below analysts’ estimates of 0.2%. 

• Core PPI (excluding Food & Energy) slowed to 2.4% from 2.8% at the same time in 2022, and below estimates of 2.6%. MoM Core PPI showed a 0.1% rise, which was below the 0.2% estimate and the same as the 0.1% of the prior month of May. 

• The Canadian Dollar also trades higher after the BoC raises interest rates by 0.25%, bringing the overnight rate to 5.00% at its meeting on Wednesday. 

• Higher rates are positive for CAD (negative for USD/CAD) as they attract more foreign capital inflows increasing demand for the currency.

• Governor Tiff Macklem stressed future policy decisions would be dependent on incoming data, leaving markets unclear on whether this would be the BoC’s last hike in the tightening cycle. 

• The decision to raise rates at the July meeting had only been reached after a discussion by board members on the relative merits of leaving rates unchanged or raising them. 

• “On balance, our assessment was the cost of delaying action was larger,” Macklem concluded.

• Regarding inflation, the BoC Governor said that whilst it was welcome inflation in Canada had fallen to 3.4% in May – substantially below the 8.1% of last summer – a large number of items in the basket of goods used to calculate the Consumer Price Index (CPI) were still rising strongly. 

• “A little over half the components of the CPI basket,” had seen their prices rising more than 5%, said Macklem in the press conference after the announcement. “If you look across the basket, meat is up 6%, bread is up 13%, coffee is up 8%, baby food is up 9% … rent is up 6%,” he added. 

• Demand and consumption in the Canadian economy were still growing, said Macklem, indicating the possibility of inflation pressures ahead. 

• The sensitive housing market had also defied expectations of a slow-down and was instead showing signs of picking up despite higher interest rates increasing mortgage repayments. 

• Recent labor market stats showed 60K new jobs were filled in Canada in June, more than three times the estimated 20K. Average Hourly wages rose 3.9%, which though lower than the previous month’s 5.1%, was nevertheless buoyant. Despite the strong jobs number, the report also showed the Unemployment Rate unexpectedly rising to 5.4% from 5.2% in the previous month, and higher than the 5.3% forecast. 

• All in all, the overall positive macroeconomic data from the Canadian economy leant the BoC governing council to make their decision to raise rates to stave off incoming inflationary effects rather than wait and see.

• The BoC does not now see inflation returning to its 2% target until the middle of 2025, about 6 months later than its previous forecast. 

• Although the Canadian Dollar rose on the BoC announcement, a growing number of analysts foresee a harsher climate for the currency in the second half of 2023.

• Analysts at National Bank of Canada, Macquarie and Nomura Bank all foresee the CAD weakening in H2 of 2023. 

• “Our bearish view for the second half 2023 remains predicated on the prospect that Canada will suffer a more severe slowdown than the U.S.,” said Thierry Wizman, global currencies and interest rate strategist at Macquarie Futures USA.

• Wizman cites the negative impact higher interest rates will have on the Montreal Housing market as a major driver of a weaker CAD later in the year. 

• “The rise in rates has already happened and households will begin to feel the squeeze as fixed-rate mortgages are rolled over at higher rates,” Wizman said, in a note quoted by the Financial Post. 

• Nomura sees rate differentials and greater growth in the US as driving USD/CAD higher. 

• The negative effect of a global economic slowdown on commodity prices negatively impacting Canada’s terms of trade is the main factor dragging CAD down, according to National Bank of Canada in a note cited on Poundsterlinglive.com. 

• The US Federal Reserve is almost certain to raise rates at its July 26 meeting, given the 5.3% Core CPI still prevalent in the US, which will probably boost the US Dollar.

• Despite Wednesday’s lower-than-expected US inflation data, market gauges of the probability of a further rate hike from the Fed at their July 26 meeting put the chances at above 90%, although any further hikes in 2023 are now less probable than the Fed standing pat.  

Canadian Dollar Technical Analysis: June lows threatened

Despite recent weakness, USD/CAD is in a long-term uptrend on the weekly chart, which began at the 2021 lows. Since October 2022, the exchange rate has been in a sideways consolidation within that uptrend. Given the old saying that ‘the trend is your friend’, however, the probabilities of an eventual continuation higher marginally favor longs over shorts.

USD/CAD appears to have completed a large measured move price pattern that began forming at the March 2023 highs. This pattern resembles a 3-wave ABC correction, in which the first and third waves are of a similar length (labeled waves A and C on the chart below). 

USD/CAD’s measured move looks like it has completed, given waves A and C are of a similar length. This suggests price probably bottomed at the June 27 lows and is now at the start of a new cycle higher. 

US Dollar vs Canadian Dollar: Weekly Chart

A confluence of support situated under the June lows in the upper 1.3000s, which is made up of several longer moving averages and a major trendline, provides a backstop to further losses. Only a decisive break below 1.3050 would indicate this thick band of weighty support has been definitively broken, bringing the uptrend into doubt. 

US Dollar vs Canadian Dollar: Daily Chart

The daily chart shows USD/CAD recovered to just shy of the 1.3400 crossroads where the 50-day Simple Moving Average (SMA) is located, last Thursday, before reversing lower. 

It has since declined all through this week and is now threatening the June 27 lows at 1.3117. It is possible that price may break below those lows – however, it is unlikely to go much lower immediately below them is the confluence of support situated between 1.3080-1.3100. Only a clean break below 1.3050 would reverse the trend and suggest a much more bearish picture for USD/CAD. 

More likely, the pair will retest the level of the June 27 lows and then recover again as it forms a complex basing pattern before eventually going higher. 

It will take a decisive break above the 50-day SMA, however, to reinvigorate the USD/CAD uptrend again. Bulls marginally have the upper hand, with the odds slightly favoring a recovery and a continuation higher.