MUFG’s Derek Halpenny reports that the Canadian Dollar (CAD) has benefited from weaker United States (US) Consumer Price Index (CPI) and higher Oil prices, with spreads pointing to modest further gains versus the US Dollar (USD). However, he expects the Bank of Canada (BoC) to remain on hold, stress a sizeable output gap and mixed data, and warns that current rates pricing leaves CAD risks skewed to the downside.

Upside capped as BoC stays patient

"The Norwegian krone, the Canadian dollar and the Australian dollar are performing best behind the New Zealand dollar within G10 since the re-escalation of the conflict with the rebound in energy prices underlining the terms of trade driver of FX performance once again. The same three currencies are in the top four behind the pound covering the period since the conflict first began at the end of February. But from a relative monetary policy stance the Canadian dollar gained yesterday like the rest of G10 versus the US dollar and the 2-year nominal US-CA swap spread points to scope for some further modest gains."

"As stated above, the CPI print has certainly weakened the support for the dollar and CAD can benefit from that as well. For CAD this can be reinforced by the upturn in crude oil prices."

"However, the macro backdrop certainly points to limits to CAD gains from crude oil and today the BoC monetary policy decision should highlight the scope for patience from the BoC given the mixed macro backdrop and weaker inflation. The need for a hawkish message is far less from Governor Macklem than from Fed Chair Warsh yesterday (notwithstanding the better US CPI data)."

"With close to 20bps of tightening priced by the end of the year the risks appeared skewed to another cautious communication highlighting the scope for remaining on hold that may disappoint current rates market pricing. Nominal and real spreads, while recently moving in favour of lower USD/CAD are still at levels that point to downside risks for CAD."

"The crude oil / Brent correlation is not particularly stable and with the BoC set to remain sidelined, CAD risks are skewed to the downside given the rates pricing (80% priced for hike by year-end)."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)